Crisis theory
Crisis theory is an economic concept primarily associated with Karl Marx, which seeks to explain the tendency of profit rates to decline over time within capitalist enterprises and its repercussions on the broader economy and labor market. According to this theory, as competition among businesses intensifies, owners are compelled to reinvest larger portions of their profits to maintain competitiveness, leading to a decrease in the proportion of profit they can extract. This dynamic is rooted in Marx's labor theory of value, which posits that value is generated through human labor, distinguishing between "live labor" (human labor) and "dead labor" (capital investments).
As businesses grow and technological advancements require increased investment in constant capital (machinery and tools), the ratio of surplus capital generated decreases, ultimately triggering economic crises when profit generation falters. Marx argued that while businesses may employ strategies to counteract the decline in profit rates, such as optimizing production or extending work hours, these measures are typically only temporary fixes.
When economic crises occur, they lead to business closures and a surplus of labor in the market, causing downward pressure on wages and allowing surviving enterprises to stabilize their profit margins. Marx's critique of capitalism and his advocacy for labor control over production processes have profoundly influenced economic thought, inspiring movements and policies throughout history.
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Crisis theory
Crisis theory endeavors to explain why a capitalist enterprise’s rate of profit tends to fall over time and how this tendency impacts the overall economy and labor market. This theory was created by the influential economist and political theorist Karl Marx (1818–1883). Marx detailed the theory in Capital, Volume III (1894), the final volume in his definitive work Capital: A Critique of Political Economy.
According to crisis theory, declining profit rates are an inevitable consequence of capitalist enterprise, as market competition tends to force business owners to reinvest larger and larger percentages of their profits back into the business. Thus, while the total value generated by a capitalist enterprise tends to increase as the business grows, the percentage of that value pocketed by the business owner as profit tends to shrink. Extended across an entire economy, these declining rates of profit trigger what Marx calls a crisis, in which the system’s ability to generate meaningful profits begins to break down.
Background
Marxist crisis theory is rooted in a concept known as the “labor theory of value,” developed by classical economists such as David Ricardo (1772–1823) and Adam Smith (1723–1790). The theory holds that people create all the value in an economic system. Other elements, such as raw materials, tools, machinery, equipment, and manufacturing facilities, hold value but cannot generate more value than they already have without human labor. Marx used the term “constant capital” to describe the latter set of elements, as their value is inherent and unchanging.
According to the labor theory of value, human labor generates two types of capital: variable capital and surplus capital. Variable capital represents the amount of labor a worker must perform to create enough value to cover their wage earnings. All additional labor performed by the worker creates surplus capital, which serves as the source of profit. Marx understood the relationship between variable and surplus capital as a ratio, which he named the “ratio of surplus value.” This ratio identifies the rate at which a business creates profit, expressed as a proportional relationship between variable capital on one side and the sum of constant capital and surplus capital on the other. Higher profit rates occur when surplus capital increases relative to variable capital.
Marx built upon prevailing interpretations of the labor theory of value by proposing his crisis theory. According to Marx, businesses that generate high levels of value and profit invariably attract competitors. This, in turn, forces capitalist business owners to reinvest increasing percentages of their surplus capital back into the company rather than extracting it as profit to protect their market position. Marx also notes that as technologies improve over time, capitalists must also increase their investment in constant capital in order to maximize the operational efficiency of their businesses. Therefore, the amount of constant capital in a business tends to increase relative to the surplus capital it generates, thus reducing the rate at which it generates profit.
Overview
The Marxist view of economics holds that business owners who want their enterprises to remain competitive have no choice but to increase their constant capital investments over time. Marx also draws a distinction between human labor, which he calls “live labor,” and machine labor, which he calls “dead labor.” Surplus capital reinvestments tend to negatively impact the ratio between live labor (variable capital) and dead labor (constant capital). Thus, if the enterprise’s ratio of variable to surplus capital falls, stays the same, or increases at a slower pace than the ratio of variable to constant capital, the overall rate at which it generates profit also decreases.
Marx characterized these declines in profit rates as a tendency of capitalist systems, not a law. He noted that many factors impact profit rates, including countermeasures that can delay their decline. One such countermeasure is tied to constant capital, as economic modeling theories note that the surplus capital generated by an enterprise tends to increase as it introduces more and more dead labor to supplement or replace live labor. Alternatively, businesses can achieve more favorable variable-to-surplus capital ratios by increasing production speed or extending the length of the workday. Companies can also consolidate, combining their variable and constant capital in favorable ways that preserve advantageous profit rates. However, Marxist models hold that such interventions only serve to postpone the tendency of profit rates to continue to slow down until they stagnate and crash, putting the enterprise out of business.
Marxist crisis theory also examines how such situations impact entire economies and labor markets. As crises force enterprises out of business and as the surviving enterprises consolidate, the overall impact of constant capital diminishes significantly. This occurs, in part, because competition becomes less intense, thus reducing the need for owners to reinvest more and more of their surplus capital back into the business. At the same time, the labor market experiences an influx of supply as workers who were employed by enterprises that went out of business seek new jobs. This puts downward pressure on wages as workers compete with one another for a limited number of available positions. These factors combine to reposition the original ratio between variable and surplus capital back in favor of the business owner, allowing the cycle to begin anew.
Marx emerged as a staunch critic and opponent of the capitalist system, instead favoring economic models that put laborers, rather than business owners, in charge of the means of production and the value it generates. These ideas formed the basis of the Manifesto of the Communist Party, better known as the Communist Manifesto, which Marx coauthored with fellow German philosopher Friedrich Engels (1820–1895) in 1848. This work inspired the establishment of Communist states like the Soviet Union in the 20th century.
Bibliography
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Crotty, James. Capitalism, Macroeconomics, and Reality: Understanding Globalization, Financialization, Competition, and Crisis. Edward Elgar Publishing, 2017.
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