From International Socialist Review, Vol.20 No.1, Winter 1959, pp.22-26. [1*]
Transcribed & marked up by Einde O’ Callaghan for the Encyclopaedia of Trotskyism On-Line (ETOL).
Do the ‘deep roots’ of inflation lie in the falling rate of profit?
TWO apparently contradictory phenomena are manifest simultaneously in the American economic structure today; at least they appear contradictory in the terms by which they are often described – inflation and deflation. A vastly expanded credit system, with its mountains of fictitious capital, has debased the currency almost beyond recognition. Alongside of this, excess capacity of production shows up in idle plants, or partially operating plants, and the resultant large-scale unemployment.
On closer examination, however, these apparently contradictory phenomena turn out to be directly interrelated consequences of the disintegrating tendencies that are besetting the capitalist system.
For serious students of the laws of capitalist production this poses a number of important questions. Correct answers to these questions will enrich our understanding of the operation of these laws. From this point of view the contributions to a discussion made by Albert Phillips in The Deep Roots of Inflation have their own special merit. Needless to say, Phillips adheres to the Marxist approach in his attempt to elucidate some of these questions. He starts out from one of the basic features of capitalist production: the disproportionate expansion of constant capital (equipment and materials) as against variable capital (labor, wages) and the resulting higher organic composition of capital which fosters the tendency of the average rate of profit to fall.
On the whole, many of the important points made by Phillips contain food for thought; but his general analysis suffers from a certain weakness. It tends to be too schematic. His basic thesis seems to be that the explanation of the inflationary process “lies in the falling rate of profit along with the positive effects of the class struggle; and that the growth of debt, including state debt, and the growing intervention of the state in the economy are increasing contributory effects rather than prime causes.” (Summer International Socialist Review, p.96) This thesis is not substantiated; nor can it be substantiated in the form in which it is presented. To arrive at a more exact analysis some serious modifications will have to be made in the relationship between the above-mentioned factors, while other interconnected components need to be taken into account.
But before discussing this basic thesis, let us take another look at the relative position of capitalist production during its earlier expanding period and its present declining stage. I agree entirely with the statement made by Phillips, that capitalism during its progressive youth – roughly prior to the twentieth century, – was able to lower prices and simultaneously extend the market, expand production, profits and the accumulation of capital; to absorb lowering of the hours of work and to increase both real and money wages over the long run.
The process whereby this was achieved was, generally speaking, the same for capitalism everywhere. Primarily it found its expression in the transition from handicraft to manufacture and to large-scale industry. The formerly limited and scattered individual means of production were concentrated, enlarged and transformed into giant social means of production which enabled a vast increase in the productivity of labor to occur.
For the United States, however, there should be added the fact that capitalism here, during its early stage, enjoyed the exceptional opportunity to expand on a virgin continent. This permitted the rapid mechanization of old industries, the tapping of new resources, the building of new industries and the constant industrialization of new regions, which again provided for the swiftly mounting capitalization of appropriated surplus value. This process included the extermination of the Indians, the degradation of the Negro population and the turning of the mighty flood of immigrants into producers and consumers of goods pouring out from a rapidly expanding economy. The extension of the market tended to act as a self-sustaining process promoting expanded reproduction.
The changes that have taken place in the capitalist economic structure since its progressive youth are, of course, fundamental in nature. But the changes described by Phillips do not correspond to reality.
For example, he quotes the calculation made by Lewis Corey, that in American manufactures, fixed capital rose 1,738% from 1849 to 1889, output Only 1,170%.
“But,” says Phillips, “that was in another century and before the death agony of capitalism. What is happening today in this relationship makes the figures that Corey cites pale into insignificance. The total output of all goods and services in 1953 dollars went from $187.9 billion in 1939 to $367.2 billion in 1953, a rise somewhat under 100%. But in order to achieve this increase, business expenditures for new plant, and equipment rose from $5.5 billion in 1939 to $27.8 billion in 1953, an increase of close to 500%.”  (Fall International Socialist Review, p.149)
This assumed relationship of 100 to 500 (a result of faulty calculation) has led Phillips astray. And it seems likewise to be at the bottom of a whole series of erroneous assumptions: for example,
It is my impression, moreover, that Phillips has compounded these erroneous assumptions by interpreting the tendency of the falling rate of profit in absolute form; that is, in a form which must continue steadily downward to a fatal conclusion. This process would be somewhat like an uncontrolled nuclear chain reaction resulting in the inevitable explosion that converts matter into energy and leaves in its wake only the proverbial blob of atomic ash.
The trouble is that Phillips was led astray by his own careless handling of statistics. The figures he quotes for total output are in constant dollars, the figures for expenditures for new plant and equipment are in current dollars. In other words the former are figures excluding the effects of inflation, the latter are not.
To set the matter straight one needs merely to measure both items in current dollars. Such figures are the most easily accessible and they will work out the same way for both items. These figures are as follows: The total output of goods, measured in current dollars, went from $91.3 billion in 1939 to $364.9 billion in 1953, a rise of about 400%. Also based on current dollars, expenditures for new plant and equipment rose from $5.5 billion in 1939 to $27.8 billion in 1953 (using Phillips’ figures), an increase of about 500%.  Thus instead of an erroneously assumed relationship of 100 to 500, we have an actual relationship of about 400 to 500.
If we extend this over a longer period we get a more complete picture. Let us compare the year of 1929 with 1956. Both represent peak years of twentieth century capitalist prosperity in the United States. The period as a whole includes its deepest and longest depression as well as its highest and most sustained war and armaments “prosperity.” During this period total output of goods and services, measured in current dollars, rose from $104.4 billion in 1929 to $414.1 billion in 1956, an increase of 396%. Business expenditures for new plant and equipment, also measured in current dollars, went up from $9.2 billion in 1929 to $35.1 billion in 1956, an increase of 385%. Thus we notice that the rise is about equal for both items or, in other words, the increase in output kept abreast with the increasing cost of capital investment. Looking at this relationship from another angle we find that the ratio of investment for new plant and equipment to total output, remained constant at a little less than 9% for both 1929 and 1956.
With these corrections introduced we can get a better view of the basic thesis propounded by Phillips. Is the falling rate of profit, along with the positive effects of the class struggle, the primary cause of inflation, while the growth of debt, including state debt, etc., adds only contributory effects?
We start out in agreement, as previously stated, that the transition from handicraft to manufacture and to large-scale industry enabled the bourgeoisie to cheapen the commodities produced.
In England, this transition dates back to the Industrial Revolution. In this, country it is possible to fix a fairly exact date. The United States Census of 1900 is authority for the statement that “the factory system obtained its first foothold in the United States during the period” of the Embargo and the War of 1812.” But the same authority informs us “it was not until about 1840 that the factory method of manufacture ... began rapidly to force from the market the handmade commodities with which every community had hitherto supplied itself,”
Let us now follow the wholesale price index from that period to the present day. We learn from the Bureau of Labor Statistics data, with 1926 as 100, that the index of wholesale prices stood in 1840 at 71.1 and reached its lowest point of 46.5 in 1896. During the Civil War and World War I the index went up quite high for a relatively short period on both occasions, to drop somewhat lower during the Great Depression and reach 77.1 in 1939. Since 1939, however, the wholesale price index has made a steeply upward climb, practically uninterrupted for two decades, without any sign of reversal of this trend. Projecting it forward with 1926 still as 100, instead of the average of 1947-49 now in common use as the base, by October, 1955, the wholesale price index stands at 184.9, a rise of almost two and one-half times since 1939.
For the United States this is an entirely new phenomenon. Its reverse side is the drastic currency depreciation; and this phenomenon of the last twenty years is rightly named inflation. Moreover, the reluctance of the American people to buy government bonds to finance the present huge federal budget deficit seems to indicate that the further rotting of the dollar is now accepted as inevitable as death and taxes.
Popular awareness of inflation seems to spring from a more realistic appraisal of what it really is than all the bewildered effusions of the bourgeois economists mentioned by Phillips, For if the latter were to approach an explanation of the problem, they would have to turn their attention first of all to one of the basic institutions of capitalist society – the credit system. There they would find the most direct source of the origin and growth of inflation.
Marx made the scathing indictment that “the credit system ... develops the incentive of capitalist production, the accumulation of wealth by the appropriation and exploitation of the labor of others to the purest and most colossal form of gambling and swindling, and reduces more and more the number of those who exploit the social wealth.” (Capital, Vol.III, p.522).
Marx also provided us with a thorough analysis of the function of money, and tokens of money, in capitalist society. He explained how money becomes capital in the process of production by the intervention of the commodity labor power, “a commodity whose use value possesses the peculiar property of being a source of value.” Marx similarly explained the two-fold function of money in the process of circulation. In the one instance, in its abstract or ideal form, it becomes the socially recognized measure of value inasmuch as it represents the incarnation of human labor. In its concrete form, money performs the function of a socially recognized medium of exchange (including the function of means of deferred payments or credit).
In the latter case, the function is transient. After having mediated at one point, between purchaser and seller, the money moves away to repeat its office elsewhere. Because of being a “transient and objective reflex of the prices of commodities,” said Marx, money (gold or silver) is “capable of being replaced by a token,” but “only in so far as it functions exclusively as coin, or as the circulating medium, and as nothing else.” (Capital, Vol.I, pp.144-145).
Marx subjected interest-bearing capital, banking capital – which forms the essential basis of operation within the credit structure – to a careful examination. While he was aware that such capital in the hands of the banker appears as an independent self-expanding value, he demonstrated how it can in reality have no independent function separate and apart from capital employed in the process of production. And Marx found a great proportion of such “money capital” to be fictitious. From this he drew the observation:
“With the development of the credit system and of interest-bearing capital all capital seems to double, or even treble, itself by the various modes, in which the same capital, or perhaps the same claim on a debt, appears in different forms in different hands.” (Capital, Vol.III, p.553).
This purest form of gambling and swindling has today gone far beyond anything ever experienced at the time of Marx. The mountains of fictitious capital created to finance World War II, the Korean “police action” and the subsequent armaments race served as the initial means to debase the currency. Goethe was modest, indeed, when in the second part of Faust he blamed the invention of paper money on Mephistopheles. The modern bankers and their governmental agencies have done much better; they have manufactured money out of thin air to finance both public and private debt. This has left its imprint on all banking capital, on the money supply and the liquid assets of the nation. All these are debased almost beyond recognition.
During World War II, for example, the government borrowed money from the banks and from the citizens. About one hundred billion dollars were borrowed from commercial banks, giving government bonds as security. The government spent that capital. It was spent for bullets, bombs, planes, tanks and battleships blown to bits or sunk long ago. But the government bonds – gilt-edged to be sure, yet still only shadows of capital – remain in the banks as deposits upon which the bankers can again make loans to the tune of six times their face “value.” Thus the capital – whose progeny, interest, is paid by the state – is illusory, fictitious capital. It consists of certificates of indebtedness, to which corporate and private debts add their load. Moreover, the interest and principal on those bonds can be paid only by taxing the production of real capital.
The heavy injection of fictitious capital into the credit system is illustrated by the following: At the end of 1939 currency in circulation and demand deposits in banks (check-book money) amounted to about $36 billion. At the end of 1952, when the most intense inflationary heat began to subside, but not to disappear, currency in circulation and check-book money had risen to about $129 billion. It had more than trebled! The extra $93 billion entered into and vastly augmented the money supply of the nation.
For the United States this is also an entirely new phenomenon, of which the steeply rising price index expresses the other side of the reality. Never before in American history has anything even approaching such a tremendous increase in the money supply occurred. And precisely in this do we find the main roots of inflation. These enormous sums of fictitious capital flowed as an element of dissolution into every pore of the financial and economic structure. There it has remained as a parasite feeding upon productive capital and drawing value away from all money capital.
New forces were thus set in motion which generated their own internal dynamic and kept on advancing beyond the control of the capitalist rulers. The quantitative increase in the money supply resulted in its qualitative decline. The almighty American dollar suffered a precipitous depreciation. As a measure of value it shrank drastically. In the short span of twenty years it has lost more than half of its purchasing power. This is the real picture of inflation, its causes and its manifestations; and inflation has become a distinguishing characteristic of capitalist disintegration wherever this system prevails. In the European capitalist nations inflation is ravaging workers’ living standards and the same uncontrollable forces are also on the rampage in the United States.
What then is the relation of the tendency of the falling average rate of profit to the present process of inflation? To be sure it always enters as a component part of the commodity price system, especially of the big monopoly concerns. So do rising labor costs, or higher wages, both nominal and real, that workers have actually gained as a result of their organization.
The really important statistic that the “successful” executive of capitalist enterprise never loses sight of, is the return on invested capital. But this in no way justifies a conclusion that either the falling rate of profit or the higher wages of workers (positive effects of the class struggle) are the basic causes of the present inflation. These, as well as a number of other factors, such as productive capacity, labor productivity, consumer markets, monopoly domination, foreign investments, interest, prices and taxes, etc., are all interconnected components of capitalist economy, its industry and finance. They all function as integral parts of its process of development; and to that extent they partake in the inflationary spiral. But it is important to understand correctly the relationship between them.
The realization of profit and the accumulation of capital is the primary urge and motivating force of all capitalist production. To increase profits the monopoly enterprises are driven ceaselessly to reduce labor costs and enlarge the scale of operation. The most direct outcome is a change in the composition of capital; and such changes underlie all the contradictions of capitalist accumulation. The tremendous growth of plant, equipment and raw materials in modern industry, operated by relatively fewer workers, is an expression of the disproportionate expansion of constant capital as against variable capital. With each new labor-saving machine installed, labor productivity rises and the absolute mass of that part of labor which is unpaid, and represents surplus value, is increased.
Living labor alone produces surplus value. But the decline of living labor employed in comparison to the volume and value of total capital it sets in motion brings about the result that the surplus value produced also tends to decline in comparison to the magnitude of total capital invested. And since the proportion of the mass of surplus value to the value of total capital employed forms the rate of profit, this rate tends to fall continuously.
Marx always insisted that the fall in the average rate of profit manifests itself as a tendency and not in absolute form. Its effects become clearly marked only under certain conditions, for instance during crises, and over long periods. But Marx also established the fact that the same causes which bring about this tendency of the falling rate of profit likewise produce the forces that counteract this tendency.
The increase in labor productivity due to the higher organic composition of capital expresses itself in a progressive increase in the absolute mass of the appropriated surplus value or profit; thus on the whole, a relative decrease of variable capital and profit is accompanied by an absolute increase of both. There is an accelerated accumulation of capital. Generally the growth of the magnitude of total capital proceeds at a more rapid rate than that expressed by the fall of the rate of profit. And along with the growing mass of employed capital, the mass of profit increases, while the rate of profit may fall. The opposites here interpenetrate. The same causes which bring about the tendency of the falling rate of profit simultaneously promote an increase in the mass of profit.
However, the rate of profit as well as the realization of surplus value depends also on other circumstances. It depends quite directly on what Marx calls the second act of the process of production – the sale of the products. The constellation of the market is, therefore, pertinent to our discussion. It can throw further light on the relation of the falling rate of profit to inflation.
As we have seen, the period of inflation coincides with the existence of a huge artificial market for armaments production. Precisely t his artificial market created the extraordinary conditions in which the factors counteracting the tendency of the falling rate of profit were the most active. I leave aside here the factors which have become familiar in the past, such as: greater intensity in the exploitation of labor, cheapening of the elements of constant capital, export of capital, etc. To be sure these were still present, but more important now is a consideration of the special conditions created by the armaments markets. These can be set down about as follows:
These factors counterbalancing the tendency of the falling rate of profit were active simultaneously. Not only did they help to overcome the effects on profit caused by the recessions of 1948-49 and 1953-54, but the rate of profit apparently experienced a new, even though temporary, rise.
That this was actually the case seems indicated by the estimated rates of profit of leading manufacturing corporations, submitted by Reuther to the 1957 UAW convention. Based on data from the First National City Bank Monthly Letter, profits after taxes per $100 of investment rose for autos and trucks from $23.50 in 1929 to $29.10 in 1955. For tire and rubber products the corresponding figures rose from $3.90 to $15.10; for aircraft and parts from $10.70 to $24.70. Other industries listed, petroleum products and non-ferrous metals, showed somewhat lesser gains. These figures, of course, reflect the inflationary process, which affects both profits and capital investments. Nonetheless, they suggest a pretty fair position for the rate of profit.
A somewhat more conservative estimate of profit rates has been presented by the Labor Research Association. It is based on tax returns to the US Bureau of Internal Revenue by all corporations from 1909 to 1946. Over this period the estimated rate of profit on total capital employed varies considerably. It starts out with 5.4%. in 1909, reaches a high point of 12% during World War I, to vanish with the great depression, rising again from 4.2% in 1939 to 8.3% in 1946. The authors admit that this estimate is on the conservative side and that it should, undoubtedly, be a good deal higher considering the particularly skillful art of concealing profits to avoid taxes that is practiced by the corporations. In this connection one needs only remember how corporation heads tremble with indignation when demands are made to “open their books.”
Meanwhile, the same causes which bring about the tendency of the falling rate of profit simultaneously promote an increase in the mass of appropriated surplus value or profit. At no other time has this been more sharply illuminated than during the period of the artificially created armaments market. Profits after taxes of all corporations rose from $5.0 billion in 1939 to $21.0 billion in 1955, an increase of 420%. Even allowing for the effects of inflation, this is a phenomenal rise indeed. Moreover, capitalists are generally enriched by a smaller yield on a larger volume of invested capital. For example, according to the Labor Research Association estimates, in 1918, the last year of World War I, corporate profits showed a rate of 6.6% on a net worth amounting to a mere $75.7 billion. But in 1945, the last year of World War II, the corporations pocketed a yield of 6.4% on a total net worth of $165.0 billion.
It is true that the tendency of the falling rate of profit and the struggle against it conditions a fundamental aspect of capitalist development. But it must be acknowledged that precisely this period of raging inflation, beginning with 1939, has been exceptionally favorable to capitalism both as regards the rate of profit and the mass of profit.
Obviously, this phenomenal profit gain, and the great magnitude of realized surplus value that it represents, was made possible primarily by the constantly higher labor productivity. The tremendous diversion of labor, of production and of national income to turn out armaments for hot wars and for the cold war could take place only on the solid underpinning of the high American labor productivity.
It is difficult to measure labor productivity; estimates made are usually rough approximations. However, the calculation by Edwin Clague, the Commissioner of Labor Statistics, appearing in Scientific American, September 1951, seems reasonable. Clague computed the productivity improvement for the whole economy at an average rate of 2% per year from 1900 to 1950. Phillips quotes Labors Economic Review (AFL-CIO) which computed an annual productivity increase of 3.0% to 3.6% from 1947 to 1956. These higher figures may have reference only to manufacture where such gains are always greater. Nevertheless, the constant and substantial increase in labor productivity is clearly evident.
But the assumption repeatedly asserted by Phillips that “the increase in labor productivity tends to decline in proportion to the organic change in the composition of capital,” is entirely without foundation in fact. In the long run, as we have seen, from 1929 to 1955, the rise in total output held up about evenly with the rise in total capital outlays.
Viewing this question of labor productivity from another angle, we can add the results of compilations just made public by the Federal Reserve Board, of output by US factories, and by the Bureau of Labor Statistics giving the number of production workers employed. Both cover the last decade. The results are a 35% gain in output with 6% fewer workers employed. And the auto manufacturers, who have an especially keen sense of the rate of return on their invested capital, have been quite willing over a period of years to pay the annual 2½% wage increase for the so-called improvements factor. All in all, the evidence should leave little doubt that the rise in labor productivity has kept level with the higher organic composition of capital.
To be sure this labor productivity growth does not signify a second industrial revolution. And I am in complete agreement with Phillips that a second industrial revolution under capitalist auspices is precluded. My agreement however, derives from entirely different considerations than those given by Phillips which are summed up, if I understand him correctly, in prohibitive costs.
Phillips presents a number of statements to this effect from industrial magnates, bourgeois economists and other mouthpieces of Big Business. What does it all add up to? These statements are perfect examples of the plaints, usually interlarded with brazen hypocrisy, that customarily emanate from these sources as a justification for higher prices, and as a means of counteracting union demands for higher wages.
J. Pierpont Morgan, the elder, is reputed to have been fond of saying: Every man can give a good reason for what he is doing; but these same men also have their real reasons – or words to that effect. I shall try to indicate the real reason for the statements mentioned by Phillips.
Whether or not “staggering costs” stand in the way of modern instrumentation, or automation, of the capitalist-owned productive plants is highly debatable. Wassily Leontief, the Harvard economist referred to by Phillips, states the contrary view as follows:
“The estimated cost of total instrumentation of a new modern plant to automatize it as fully as possible today, ranges from 1 to 19 per cent (depending on the industry) of total investment in process equipment. The average for all industries would be about 6 per cent.”
“... the smoother and better balanced operation of self-regulating plants has already shown that they can function with less capitalization than a non-automatic plant of identical capacity.” (Scientific American, September 1952)
To illuminate the other side of the question, let us recall the case of the steel industry during the late forties. When the cold war and the armaments race began there were loud and insistent calls for enlarged steel capacity from President Truman which were echoed by the labor lieutenants of capitalism. The steel barons had an answer; it was a resounding, No! They pleaded poverty. Because of their heavy capital investment, they asserted, their breakeven point – the point of production below which profits would vanish – had by 1949 reached 70% to 75% of capacity. But behind their pleas lurked their fear of excess capacity, the fixed charges on which would eat into surplus value and profits realized. And besides, their vested interest in existing technology paid off handsomely.
In fact, it paid off so well that Bert Seidman, of the AFL-CIO Department of Research, could comment this year:
“Since 1939 the profits per man-hour of US Steel have gone up from 13 cents to $1.80, or an increase of 1,284 per cent.”
With this, we begin to approach some of the real reasons for reluctance by the dominant monopoly entrepreneurs to take advantage of the new possibilities offered by electronics, automation and nuclear energy. They may well cast envious eyes Eastward. Already the Soviet economy with its nationalized property and state planning is infinitely more capable than is capitalism of adapting to this higher level of technology. Not hampered by private profit motives, Soviet industry is able to skip stages and make a leap directly into the new forms of production while capitalism remains hesitant – except where implements of war are concerned – on the brink of this new era.
The real truth is that capitalism is incapable of continuous, planned utilization of all the means and techniques that are available. And this arises out of the simple fact that it is incapable of developing commensurately the conditions of consumption.
The higher organic composition of capital with its greater labor productivity, inherently the basis of potential plenty, tends under capitalism to lead in the opposite direction. Not only does it foster the tendency of the falling average rate of profit. It sets in motion simultaneously a restriction on the growth of the market by imposing limitations upon the purchasing power of the great mass of the workers. For it is a fact that profits always race ahead of wages, and wages fall relatively to output and profits. Capitalism develops the forces of production more rapidly than the means of consumption.
But the expansion of constant capital at the expense of variable capital also reduces the demand for labor. Compared to the total capital set in motion, the labor force employed diminishes steadily. Therefore, the greater magnitude of capital, produced by the workers, becomes the means whereby they are themselves made relatively superfluous. The workers are face to face with the twin scourge of unemployment and inflation.
In the epoch of capitalist crisis and disintegration every serious advance in technique quickly renders obsolete existing capital equipment. It raises to more menacing proportions the ever-present spectre of excess capacity, of overproduction of capital. Simultaneously it deepens the contradictions of its mode of production and thereby intensifies the inner tensions and conflicts of capitalist society.
From its earlier progressive position, the capitalist mode of production is now in the stage of decline and decay. The constant expansion of the internal and external market, formerly operating as a self-sustaining process promoting expanded reproduction, has been thrown into reverse in a relatively contracted internal market and on an absolutely restricted world market. Heavy armaments production, devoid of use values, a drain on the economy; and manipulations of the credit system, with attendant inflation, are applied in an effort to prop up the sagging economic structure. These characteristics of the epoch lead to the conclusion that for the capitalist mode of production a second industrial revolution is precluded. It is precluded because on the historical scale the capitalist relations of production, i.e., property relations, which formerly served as forms of development of the forces of production, are now fetters on production.
1*. This is a response to the discussion article The Deep Roots of Inflation by Albert Phillips, published in the summer and fall issues of the International Socialist Review.
1. The “$27.8 billion” should be $28.7 billion, apparently, and for 1955, not “1953.” The figure of “$187.9 billion” for 1939 likewise appears to be inaccurate.
2. All figures quoted by me, unless otherwise noted, are from official government sources as presented in the Statistical Abstract of the United States.
Last updated: 23.12.2005