$$ \bar{w}l_{n-1} + a_{n-1}p_1(1+r_w) + (\rho_{n-1} + \rho_a)\Lambda_{n-1} + |\rho_n|\Lambda_n = p_w'' $$

$$ \bar{w}l_n + a_n p_1 (1 + r_w) + \rho_a \Lambda_n = p_w'' $$

What lessons can be learned from this analysis? The first of these lessons is that rent and profit are revenues of the same nature: this is shown by the case in which capitalist enterprises are themselves owners of the land they exploit, in which case the introduction of land into their means of production may leave prices and the average rate of profit unchanged and be interpreted simply as the appearance of additional differences between the actual rates of profit of the different enterprises, other than those resulting from the difference of production techniques used to produce the same good, a situation which must also be addressed.

## 2. Type II differential rent for Sraffa and Marx

This example and this remark lead us to the case of the production of wheat with different techniques on homogeneous land. This case is dealt with by Sraffa in § 87 of “Production of Commodities by Means of Commodities”, and leads him to state in § 88: “While the scarcity of land thus provides the background from which rent arises, the only evidence of this scarcity to be found in the process of production is the duality of methods on lands of the same quality: if there were no scarcity, only one method, the cheapest, would be used on the land and there could be no rent” (Sraffa, 1960, p. 91).

This remark from Sraffa is totally erroneous. Indeed, if these homogeneous lands are cultivated by one and the same capitalist enterprise (a single "farmer"), the diversity of the techniques used by this farmer does not matter. This diversity may arise from historical reasons, which can come from differences in the rhythm of introduction of new machines: the average rate of profit of such a firm depends on the average cost of these different techniques, so that there can be only one equation for this quality of land in the price system, which remains unchanged, and the rent remains that already determined for this category of land.

It is only if several different capitalist firms are cultivating these homogeneous lands of the same fertility, and when each of them is using a different technique, that the system of equations for the corresponding lands must then be modified. Let us suppose that these lands have the same fertility, and that this corresponds to a land of rank $\Lambda_f$. Let us also assume that there are three firms rated 1, 2 and 3 which cultivate this land and use different techniques materialized by different vectors $a_{f1}$, $a_{f2}$ and $a_{f3}$, and different quantities of labor $l_{f1}$, $l_{f2}$ and $l_{f3}$. The equation hitherto unique for land $\Lambda_f$ becomes:

$$ \bar{w}l_{f1} + a_{f1}p_1(1+r_{w1}) + (\rho_f + \rho_a)\Lambda_f + |\rho_n|\Lambda_n = p_w'' $$

$$ \bar{w}l_{f2} + a_{f2}p_1(1+r_{w2}) + (\rho_f + \rho_a)\Lambda_f + |\rho_n|\Lambda_n = p_w'' \quad (\text{System 5}) $$
$$ \bar{w}_{f3} + a_{f3}p_1(1 + r_{w3}) + (\rho_f + \rho_a)\Lambda_f + |\rho_n|\Lambda_n = p_w'' $$

The price $p_w''$ is given and the rent that has already been fixed for the category of homogeneous land $\Lambda_f$ has no reason to change, since overall conditions of production have not changed. The only thing that can vary is the rate of profit: we can see in this system of equations that the average rate of profit existing for the three enterprises considered as a whole has been replaced by three separate profit rates, $r_{w1}$, $r_{w2}$ and $r_{w3}$ for each of the three firms, respectively. We thus verify that rent is not explained by scarcity: besides, the lands of fertility $f$ may have any rank in the order of fertility. These homogeneous lands do not necessarily correspond to the marginal land, whereas in the example of Sraffa this additional hypothesis must be made so that its reasoning introducing scarcity can be pursued, or there is only one and unique category of land, which is even less realistic. But our reasoning remains valid even if land $\Lambda_f$ is replaced by marginal land $\Lambda_n$.

Indeed, Sraffa's mistake here is to confuse profit and rent: whether or not in the production process there are non-produced means of production such as land, the difference in production techniques within a branch producing the same product is inevitable, unless we assume that there is only one firm per branch, which would be absurd. Even the fact that a given firm employs only one technique is surely infrequent, since fixed capital is rarely replaced in a block and at one point in time, which at all times leads to the coexistence of techniques of a slightly different nature in the same firm. Consequently, it is the difference in production techniques, and not scarcity, which explains the differentiation of profit rates within the same industry.

This analysis allows us to conclude by validating our initial statement: just as profit does not reward productivity, but the property of means of production, rent as well rewards the property and not the “fertility” or “scarcity” of land or any other non-produced means of production. Profit and rent are therefore revenues of the same nature, since both are levied on surplus-value, and suppose the redistribution of this surplus-value, of which they represent distinct parts. This implies that owners of non-produced or rent-producing means of production are competing, whether they realize it or not, with the other owners of means of production for the redistribution of this surplus value.

This redistribution of surplus-value, however, is effected in different ways. Profit is taken to allow the replacement of fixed capital supposed to have been consumed in the production process, through the depreciation of capital in use, but it has been shown that it is also used to a large extent for the consumption of capitalists. Rent is levied by the owners of unproduced means of production, who may also be capitalists, who are not prohibited from purchasing land or other unproduced means of production. With respect to the use of rent under the model developed so far, rent can be consumed or used for the purchase of fixed capital, being understood that in the latter case landowners also become capitalists. Moreover, and as we have shown, rent takes two different forms, which are of the same nature, but which can
nevertheless be analytically distinguished: differential rent and absolute rent, and on this point
one can only partially correct Marx.

Differential rent is due to the heterogeneity of land, to their difference in fertility. Knowing that the order of land classification may vary according to the change in the rate of profit and the price system, there is nothing such as an absolute fertility, which is why we must be careful when using this term. But the phenomenon corresponds in any case to what Marx called differential rent of type I. With regard to what Marx called differential rent of type II, resulting from differences of production techniques on homogeneous lands, and which Sraffa considers to be a rent of scarcity (of this homogeneous land), on the other hand, it has been demonstrated that this rent does not exist as such, because it actually resolves in profit rate differentials. Marx and Sraffa are therefore both wrong on this point.

Of course, this position is partly a question of vocabulary, but if we agreed to name rent what is in fact a difference between rates of profit in the production of the same good, then there would be rents everywhere. This is nevertheless the position of a few economists, such as Jean-Marie Huriot, in an article of synthesis, published in 1983: “*Rentes différentielles et rentes absolues: un réexamen*” (“Differential rents and absolute rents: a review”). It is true that for this economist, rent always refers to scarcity, and that scarcity is everywhere, whereas in the analysis which has just been conducted rent has been explained without needing to introduce the concept of scarcity. It is therefore essential to reserve the term of rent not only to the case of unproduced means of production but also to cases where the difference in production costs arises from the heterogeneous nature of these non-produced means of production, and not just from differences in the nature of the techniques employed. Otherwise, even with the existence of unproduced means of production, it is better to use the term quasi-rent, which would therefore correspond to the differential rent of type II for Marx, or to the case of homogeneous land with different techniques for Sraffa.

An example will make it easier to understand, that of the rent of location. If it is simply what Huriot names in his article the distance-differential rent, which is noted by him as ρδ, this “rent” arises from the greater or lesser distance from a land in relation to the market (the furthest being the rent-less land). However if we go back to our example of wheat production, this "rent" is in fact based on the simple addition of a transport cost proportional to this distance among the inputs of wheat production. The greater the distance, the more distant the land and the higher the transport cost, hence the lower the rent, to the point of canceling out at the maximum economically possible distance, that of the marginal land. But this higher transport cost actually corresponds to nothing else than a change in the production technique, in which transport cost has an increasingly important technical coefficient, as the distance of the cultivated land increases. This reduces the rate of profit in relation to the average rate of profit on all the lands concerned, which may be either homogeneous or heterogeneous: one can have lands otherwise highly fertile at a great distance, and less fertile lands nearby, or homogeneous lands at different distances.

In these different cases, since it is an unproduced means of production - land, which is used,
and since it is one of its characteristics (its distance from the market), which is involved, we
can admit to use the term quasi-rent for surplus profits resulting from the difference in transport costs with respect to the most distant land. On the other hand, if any manufactured good is produced at different distances from the market, the difference in transport costs is equivalent, from a formal point of view, to a difference in techniques. But if there is no use of unproduced means of production, the differences in the rate of profit resulting from this difference in techniques do not, in our opinion, justify the use of the term quasi-rent in relation to and as a kind of explanation for these differences.

In both cases, however, what also justifies not to use the term “rent” is that the price of the produced commodity remains unchanged, as there is no particular reason for it to change, whereas in the case of rent proper we saw well that its existence, whether differential or absolute, necessarily raised prices. On the other hand, in the case of a pseudo-rent of location, there is no rent strictly speaking because the property of land is not the property of distance. Moreover, it is sufficient for the market to change its location for quasi-rents or profit rate differentials to be modified, without any change in property rights.

The analysis performed so far now allows us to provide two new principles concerning rent.

**Principle 24:** Rent is the income that comes from the property of non-produced means of production, such as land or mines, and is collected by the owners of these means of production. There are two kinds of rent: differential rent and absolute rent. Differential rent comes only from the heterogeneity of each type of non-produced means of production, i.e. from differences in their intrinsic characteristics, and varies according to this heterogeneity. Because of its origin in property rights, absolute rent is the rent perceived even on the least “productive” (i.e. with no differential rent) of a particular type of non-produced means of production (otherwise it would not be rented). It is also perceived on all the other non-produced means of production of the same type.

**Principles 25:** There is no rent as such coming from the heterogeneity of the techniques which can be employed by various firms using homogeneous non-produced means of production, which already pay a rent for their use. This heterogeneity only results in profit rate differentials. However, owing to the use of non-produced means of production, the corresponding differences in production costs from the average cost can be called “quasi-rents”, to distinguish them from other types of profit differentials.

### 3. The effect of rent on the price system and distribution

It is system of equations (4) above which fully accounts for the effects of rents on the price system. Compared to the price system that would prevail in the absence of rent and would result in an average price of wheat equal to $p_w$, it shows that taking rent into account leads to a price increase, such that the unit price of wheat $p_w$ is increased by the amount of rent, and thus becomes:

$$p_w'' = p_w' + \rho_a \Lambda_i \quad \text{with } \rho_a > 0, \quad \begin{array}{l} \rho_i > 0 \text{ and } i=1 \\ \rho_i < 0 \text{ and } i=g+1 \end{array} \quad (4)$$
And since we have: $p'_{w} = p_{w} + \rho_{1}\Lambda_{1} + |\rho_{n}|\Lambda_{n}$ (see system of equations 3), we get:

$$p''_{w} = p'_{w} + \rho_{a}\Lambda_{i} = p_{w} + (\rho_{i} + \rho_{a})\Lambda_{i} + |\rho_{n}|\Lambda_{n} \quad (5)$$

Equation (5) shows that in the real world – apart from the marginal non-produced means of production, on which there is no differential rent, there is no such thing as a “pure” rent, because all rents are a combination of a differential rent and an absolute rent.

We recall that $\rho_a$ is the level of absolute rent, which must be paid even to the owner of the least fertile land to make him decide to rent his land, and that $\rho_n|\Lambda_n|$ is equal in absolute value to the amount of the deficit (which we called negative rent) that would appear on marginal land if the price of wheat were set at the level corresponding to the average rate of profit and the absence of rent. The level of $\rho_n$ is not arbitrary, since it is determined for a given price system and a given rate of profit by the conditions of production on the least fertile land. On the other hand, the level of $\rho_a$ depends on what might be called the balance of power between owners of non-produced means of production and capitalists who pay the rents. In the real world this balance of power is generally arbitrated or regulated by the State, but in the case of some primary commodities like oil, it can also be the subject of negotiations between States and oil companies, and even of conflicts between States, as shown by the way oil fields are exploited.

The effect of rent on the rate of surplus-value and on the redistribution of surplus-value is different according to whether rent appears in the production of consumer goods or in the production of fixed capital, i.e. in Section II or in Section I of the production system.

With respect to a situation where there is no rent, and with the assumption of a constant profit rate, the levy of rent in Section II results in an increase in the overall price of consumer goods, which is known to be equal in the absence of rent to $Y_{II} = L_{II} \cdot \frac{1+k}{1-c}$. Since $L_{II}$ and $k$ do not vary, the introduction of rent is equivalent to an increase in $c$ (the share of the value of consumption going to capitalists) by an amount $c'_{II}$ (with $c + c'_{II} = c'$). This amount $c'_{II}$ is the share that the consumption of rent receivers in Section II represents in total consumption. The overall price of consumer goods thus becomes:

$$Y'_{II} = L_{II} \cdot \frac{1+k}{1-(c+c'_{II})} \quad (6)$$

In Section I, the drawdown of rent results in an increase in the price of fixed capital, which is known to be equal in the absence of a rent to $Y_I = \frac{L_I}{(1-a)(1-c*)}$, with again a constant profit rate. The introduction of rent in this section can only take the form of an increase in total rent corresponding to $c'_I$, i.e. the additional share of total consumption obtained by rent receivers in section I. The price of fixed capital produced in Section I then becomes:
$$Y_I = \frac{L_I}{(1-a)[1-(c^*+c^{*'})]} \qquad (7)$$

As for the rate of surplus-value, that is $k_c = \frac{k+c}{1-c}$, only the rent affecting the price of consumer goods modifies it, by increasing it to $k'_c = \frac{k+(c+c')}{1-(c+c')}$, and we know that $k'_c$ is also the profits/wages ratio in Section II. The consumption of rentiers in Section II is therefore levied on the consumption of workers. On the other hand, rent levied in section I does not modify the rate of surplus-value, but affects the distribution of surplus-value to the detriment of capitalists: the consumption of rentiers in Section I is deducted from the total consumption of capitalists, through the rise in the price of fixed capital caused by the collection of the rent.

Now that these clarifications have been made, we shall try to answer briefly the question of what the distinct effects of an increase in differential rent or absolute rent may be.

In the first place, an increase in absolute rent without an increase in the differential rent implies that the use of non-produced means of production remains unchanged. To take the example of wheat, there is no increase in wheat production and therefore in the cultivation of new, less fertile land. We are then brought back to the analysis which has just been made of the introduction of rent, which necessarily includes an element of absolute rent, in a system in which there was no rent. We have just seen that the introduction of rent comes down to levying a share of surplus-value on the sale of any good or service by selling it with an unchanged value but at an increased price which integrates the amount of the rent. As such, this price is therefore situated above the price which would result from the application and the collection of the average pre-existing rate of profit for the production system and the section concerned. This is not linked to an increase in the cost of production itself, but is due to the fact that the producer of that good or service is subject to the market power of the owner of unproduced means of production, with the assumption that he can pass on the amount of this rent in his sale price.

The mechanism for levying this amount is in any case similar to that which makes it possible to realize a surplus-value in the form of profits through the fixing of prices, which clearly shows the common nature of rent and profit, either in the form of average profits or of quasi-rents. Depending on whether the commodity for which the pricing power that will generate a rent or quasi-rent is produced in Section I or Section II, levying an absolute rent or a quasi-rent actually amounts, as we have seen, to an increase in the value of variables c or c*, and thus increases the price of consumer goods or fixed capital at global level.

We also just saw that the increase of c and hence the increase of $\gamma$ leads to an increase in the rate of surplus-value $k_c$. The result on the overall rate of profit will be analyzed later, but the object of this work is not to carry out a detailed analysis of all the consequences of an increase in the amount of absolute rent. It is important to note, however, that the appearance or increase of an absolute rent or a quasi-rent in a production system can only have a disruptive
effect on the realization of the product at global level, since such a phenomenon necessarily
modifies the conditions for the sharing of surplus-value and hence for the realization of
profits, which depend in part, as we must recall, on the successive expenditure (in the logical
sense) of previously realized profits.

In the case of workers, the increase in surplus-value necessarily triggers a reduction in their share in total consumption (hence in their demand for consumer goods), and in a decrease in the value of labor-power. As regards now capitalists, there is no particular reason to imagine that the collectors of absolute rents and quasi-rents spend them in conditions which make it possible to keep unchanged the reproduction of the system.

In particular, if the collection of a rent or a quasi-rent concerns the sector producing fixed capital, two cases are possible. If capitalists of section I can pass it on through their price, they will keep their profits at an unchanged level. But if they cannot pass it on through their own price, the result is a corresponding reduction of their profits for capitalists of the same section. To avoid it, they will therefore seek to pass on the corresponding levy by reducing wages.

As for capitalists of section II producing consumer goods, in reaction to the rise in the price of fixed capital resulting from the appearance or increase of a rent in section I, they are able to directly increase the rate of surplus-value by increasing the price of consumer goods. But if they cannot pass on the rent increase through an increase in their price to maintain their own profits, they too will seek to reduce wages. Let us conclude, then, that any increase in a rent or a quasi-rent can only have an inflationary effect and create a strong incentive for a fall in wages, and the cumulative effect of these two phenomena must inevitably lead to a fall in the consumption of workers.

As regards the effects of an increase in differential rent, they are complex, and therefore will
be analyzed only very briefly here.

To limit ourselves to a few preliminary considerations, the effects of differential rent are not
necessarily those foreseen by Ricardo in his “Essay on Profits”. Indeed, the increase in
differential rent linked to the use for production of new non-produced means of production, in
this case linked to the cultivation of new lands, can be analyzed as resulting from an increase
in the average cost of the commodity concerned.

Indeed, since the price integrating the differential rent is $p'_{w} = p_{w} + |\rho_{n}|\Lambda_{n}$ this means that on the new marginal land the negative differential between the cost of production and the average price (excluding rent) i.e. $p_{w}$, has increased. Moreover, even with an unchanged production technique on a new cultivated land, the decrease in the quantity of wheat produced resulting from the lower fertility of the land is equivalent to an increase in the unit value of the commodity concerned, which comes as well from an increase in direct labor (l) than indirect labor (vector a) used in its production. In both cases, this increase in value reflects an increase in the cost of production. But this does not have the same effect according to the section concerned: it raises $L_{l}$ if the non-produced means of production concerned is used for
the production of fixed capital, or $L_{II}$ if the non-produced means of production concerned is used in the production of consumer goods.

In the first case we have an increase in the rate of primary surplus-value $\frac{L_I}{L_{II}} = k$, and in the second case a decrease of this rate! Since $k_c = \frac{k+c}{1-c}$, we can deduct from this that, in the first case where the increase in the differential rent occurs in Section I, there is an increase in $k_c$. Its influence on the rate of profit will be touched upon later. The parallel increase in variable c*' has no effect on the rate of surplus value.

On the other hand, in the second case, where the increase in differential rent occurs in Section II, things are not as simple. Since $k'_c = \frac{k+(c+c')}{1-(c+c')}$, the decrease in $k$ resulting from the increase in $L_{II}$ goes indeed in the direction of a decrease in $k'_c$. But if capitalists of section II can raise their prices up to the increase in differential rent, by passing it on to the prices of consumer goods, then the corresponding fall in the rate of surplus-value $k'_c$ is offset by the increase in c', the share of the consumption of rentiers in total consumption, which is added to variable c whose level remains unchanged. The question of knowing whether the final result will be a fall or an increase in the rate of surplus-value $k_c$ depends on the values taken by $k$ and $c'$!

It is therefore only in the first case, where differential rent increases in section I, that one is assured to be in the "Ricardian" situation where an increase in differential rent and the rate of surplus-value entails a decline in the rate of profit. In the second case, where the differential rent increases in Section II, a fall in the rate of profit remains possible, but not certain, if the increase in $L_{II}$ and the decrease in $k$ are strong enough to prevail on the rise of $c'$.

However, and in both cases, an increase in differential rent necessarily entails a redistribution of surplus-value, and therefore a modification of its distribution to the detriment of capitalists and in favor of rentiers. These preliminary considerations as regards the consequences of differential rent will thus be no more developed. However they allow us to state two last principles regarding rent.

**Principle 26:** Actual rents are always a combination of differential and absolute rents. Whatever their combination, the nature of rent is not different from that of profits: rent is also a transfer income, which is levied as a part of total surplus-value. Changes in differential rents can result from an exogenous change in the price system. They also correspond to changes in the scale of production, implying the use of additional non-produced means of production (in the case of an increase). Such changes therefore always entail a change in the value of the product and the price system.

**Principle 27:** Theoretically, for a given and fixed value of the product, if an increase in rent (hence absolute rent) could leave prices unchanged, the amount of surplus-value
would not change, and the amount of rent would be deducted from profits. In practice,
such an increase will have repercussions on prices, whose magnitude depends on the
balance of power between the three involved groups of agents: rentiers, capitalists and
workers. The ultimate effect on the amount of surplus-value and its distribution
between rentiers and capitalists will depend on the balance of power between these
groups, under the arbitration of the State.

Now that we have completed, with the examination of the question of rent, the exploration of
the various determinants of prices, it is time to take stock of all the theoretical consequences
of the different results which we have achieved in the last two parts of this book, as regards
the conceptual status of values and prices. This will be the object of the next chapter.

References

Huriot, Jean-Marie (1982). *Rentes différentielles et rentes absolues : un réexamen.*
(Differential rents and absolute rents : a review). [Rapport de recherche]. Dijon (France):
Institut de Mathématiques Economiques (IME), University of Dijon. hal-01533733. 24 pp.

Sraffa, Piero (1960). *Production of commodities by means of commodities. Prelude to a
critique of economic theory*. Cambridge (UK): Cambridge University Press.
# Chapter 16. Some theoretical lessons from the models

We shall in this chapter go back to the main lessons learned from the two models presented in previous chapters, beginning with chapter 11. These models allowed for a step by step approach to the process of circulation. They were of a great heuristic value for understanding how it works in the capitalist mode of production, a process which starts with the distribution of primary incomes paid in money at the end of the production process, and continues with the distribution of incomes and commodities produced among the various stakeholders. Among the lessons learned, a first one concerns the nature of fixed capital, and is addressed in a first section. A second one concerns the articulation of values and prices, again examined in a second section. A third one concerns the mode of formation of profits: the third section shows that there is necessarily some kind of conflict between capitalists themselves for the sharing of profits. A particular case concerns the sharing of profits between the productive system and the banking system. In a final and fourth section, all this allows us to propose some ideas about what could be a truly microeconomic price theory.

## 1. The nature of fixed capital

### 1.1. Fixed capital and circulating capital

Fixed capital is defined by most economists in opposition to circulating capital. This is a source of inaccuracy, which is symptomatic of the confusion that prevails when these issues are discussed. A good example of this theoretical position is provided again by Pasinetti, in "The Notion of Vertical Integration in Economic Analysis", an article published eight years before his book previously cited, who merely states on this question that "technology requires both circulating capital goods (which are used up within one year) and fixed capital goods (which last for more than one year)" (Pasinetti, 1973, § 2, p. 3). The distinction between fixed capital and circulating capital is thus not perceived as being a difference of nature, and therefore as a conceptual difference, but only as a difference of degree, the criterion being the period of production, empirically determined, which implies moreover that commodities could pass from one category to the other without any difficulty, depending on the length of the period! As for the adoption of the year as the usual reference period, it seems to come from the fact that agricultural production often (but not always) has an annual production cycle, or that the year is the standard accounting or fiscal period.

Let us therefore reiterate that there is a fundamental difference in nature between the two categories of capital, a difference which has nothing to do with the period of use or with the lifespan of the goods concerned. The criterion of distinction is the disappearance or not, in the production process, of the commodities concerned, in their original form, a disappearance which is generally, but not always, accompanied by their transformation as an incorporation into a final product (or another more developed intermediate product) in this process. This is the case for raw materials, which disappear in one form, but to reappear under another, in the cycle of production. This is not the case, however, for services or goods such as energy
(electricity for example) which disappear as such during the process, but without being materially "incorporated" (no more than labor) in the goods produced. Together with the fact that circulating capital can never be considered as a final good, since it does not leave the production process to be sold to end-users, this justifies that the value of circulating capital is found in the value of the final product, unlike the value of fixed capital.

It is therefore this criterion of disappearance-reappearance, but under another form, which defines circulating capital proper. In contrast the characteristic of fixed capital, besides the fact that it requires the prior existence of wage labor to make it perform its function, precisely through an interaction with labor, is that it remains immutable throughout the production process - whatever the duration of this process, during which it does not disappear as such. A machine, even when discarded, always has the same physical form, whatever its degree of wear, which generally affects only some of its parts, and none of its components - even when they are out of order, ever reappears in any form in the commodities produced with it.

There is therefore no justification for the idea that fixed capital would be "consumed productively" (as a mere raw material), and that it should therefore be treated as an intermediate consumption, transferring its value to the product, whereas it is clearly a final commodity, and as such an integral part of the final product.

Once again, at the root of the problem we find a confusion between economic theory and the empirical accounting practice whereby fixed capital is depreciated, usually on an annual basis, in a firm accounts. But this only reflects the social rule that any owner of fixed capital used in production has a vested right to recover over time the value of this fixed capital through the sale of its products. It is this accounting rule, which is purely empirical - and consubstantial with the normal operation of capitalist enterprises, which takes the place of a true logical and economic demonstration of the so-called transmission of value of this fixed capital. However such a demonstration is never produced by theoreticians who adopt this transmission as if it were self-evident, beyond pure and simple affirmations of principle not demonstrated, whereas the opposite is done, in the form of a demonstration by the absurd, in Appendix 2 of this book.

## 1.2. Intermediate goods, final goods and fixed capital

The reasons for which we considered - whatever the model, that fixed capital did not transmit in any way its value to the product, should therefore be perfectly clear. As we just indicated, this was not an assumption as such, but the result of a demonstration, which did not prevent at all these models from giving a coherent explanation of the formation of incomes and the distribution of commodities throughout the circulation process.

In contrast, at the heart of a number of problems which have been faced by economic theory, including Marxist analysis, lies the assumption of the transmission of value of fixed capital, an assumption which is never demonstrated, and acts in fact as a postulate of most economic theories. This explains why it is important to discuss this question a little more, precisely
because of its influence on circulation, and since this postulate may explain why there are
almost no reproduction schemes in economic theory.

Indeed this postulate actually comes down to treating fixed capital as an intermediate good. But any intermediate good is by definition incorporated into a final good, to become a mere part of it. Consequently, the only value produced is that of final goods, which obviously includes the value of all the intermediate goods incorporated in them, a value that cannot, however, be recognized independently a second time as the value of a final output. It is so because whatever the good it must be either an intermediate good or a final good, but cannot be both at the same time. This is a question of pure logics.

Yet this is exactly the way most economists treat fixed capital, considering it simultaneously as an intermediate good that disappears as such in the production process and whose value is therefore passed on to the goods into which it enters, and as a final good whose value is included as such in the total produced value, independently and on top of its value incorporated into other final goods. This simultaneous treatment of fixed capital as an intermediate good and as a final good is a logical blunder: because either fixed capital is an intermediate good, but in this case the value of the product of the period is equal to the value of the only final goods which remain outside of fixed capital, and cannot be anything else than consumption goods, whose value is therefore identical to the newly produced value of this same period. Or fixed capital is a final good in the same way as consumption goods, but then it cannot, by definition of what is a final good, transmit any value, because only intermediate goods transmit their value. The value of the product is thus again identical to the newly produced value (that of consumer goods as well as that of fixed capital).

Thus the analysis of realization in the circulation process shows that the treatment of fixed capital as an intermediate good is not admissible, since it requires that fixed capital be considered simultaneously as a final good, in the interpretation of Marx's reproduction schemes, or that fixed capital itself is produced without the aid of fixed capital, in a second interpretation. Marx's reproduction schemes are analyzed in Appendix 2: "The erroneous nature of Marx's reproduction schemes in Book II of Capital", at the end of this book.

It must be stressed again, however, that the mechanism of value transmission is fully justified as regards intermediate commodities, since this transmission is accompanied by their disappearance in its original form in the production process, just to reappear as transformed (under a modified form) through a physical incorporation into final goods. And we know since Lavoisier that in the real world nothing can be lost and thus can disappear in a process, without reappearing in the end of it. For its part fixed capital does not disappear in the process of production, and by the same does not emerge physically transformed from this process.

The transmission of value of true intermediate goods thus rests on a material basis, which is verified empirically in the real world, whereas the hypothetical transfer of value of fixed capital would appear metaphysical, and related to some kind of transmigration, if one forgot that it is based on the accounting practice of the capitalist mode of production and the legal ideology that underlies it.
All these remarks explain why traditional economic theory cannot but encounter a number of
conceptual problems with the treatment of fixed capital, to the extent that even statisticians
also have some difficulties in practice to deal with fixed capital, as we shall now see.

**1.3. The ambiguous treatment of fixed capital in national accounts**

It is no surprise that national accounts are also affected by the contradiction that we highlighted, since they consider that intermediate consumption also includes consumption of fixed capital, i.e. the depreciation of fixed capital during the period considered, as a result of normal wear and predictable obsolescence. Indeed the international System of National Accounts (SNA) indicates: "The distinction between intermediate consumption and gross capital formation depends on whether the goods and services involved are completely used up in the accounting period or not. If they are, the use of them is a current transaction recorded as intermediate consumption; if not it is an accumulation transaction" (United Nations, 2009, page 8 - words in italics are from the author). And the same manual defines consumption of fixed capital as: "the decline, during the course of the accounting period, in the current value of the stock of fixed assets owned and used by a producer as a result of physical deterioration, normal obsolescence or normal accidental damage" (ibidem, p. 123).

But since this intermediate consumption of fixed capital, unlike that of circulating capital per
se, is not deducted from the value of production to give the value added (the balance of the
production account), it follows that this value added is gross, that is to say, superior, for an
equivalent amount, to the creation of value realized during the period. It is indeed what the
SNA tells us: "Value added represents the contribution of labor and capital to the production
process... However, capital in the form of fixed capital has a finite life length. Some part of
value added should therefore be regarded as the reduction in value of fixed capital due to its
use in production. This allowance is called consumption of fixed capital" (ibidem, p. 103).

This theoretical position is an absurdity, but it is never seen as such by national accountants,
because they contradict themselves without even realizing it when they consider that the sum
of the actual outputs of the branches ... less intermediate consumption - *intermediate
consumption of which is excluded depreciation* (Italics characters have been added by the
author) - is equal to the value of the goods and services assigned to the end uses, and to the
sum of the added values. This last position adopted by national accountants makes it possible
to verify the identity between the value of the product of the period (the GDP) and the
purchases of the period, which allows the compilation of the national accounts without
coming up against the contradictions which were just mentioned. But one must be aware that
this position adopted surreptitiously (somehow), in practice is contradictory to the basic
theoretical position that, in so far as it is an intermediate consumption, depreciation of capital
should not be a distinct part of the value created in the period.

The equation: "value added = gross wages + taxes + interest and dividends + savings retained by companies to finance investment", is indeed correct, because it shows that depreciation, included in retained savings, is used by companies to purchase the newly produced fixed capital, which indeed is a part of the value created during the period, and therefore of the net
production of the period. If, in accordance with the theoretical position of the national accountants, assimilating depreciation of capital and intermediate consumption, depreciation was removed from the domestic product, i.e. the creation of value of the period, which does not include intermediate consumption, it would become impossible to understand how the newly produced fixed capital could be realized during that same period.

The only logical theoretical solution, because it is consistent with the equality of value created and value realized (and for national accountants this equality is always verified, since stocks are supposed to be bought by the companies that bear them), is therefore to consider that the depreciation of capital, and the amortization supposed to represent it, is not an intermediate consumption. Therefore, depreciation does not represent, except from an accounting and tax point of view, a fraction of the value of the old fixed capital. At macroeconomic level, on the contrary, it represents a fraction (whose importance certainly depends on the accounting and tax rules) of the newly produced fixed capital.

It follows from this that the purchase of capital goods constituting fixed capital must be considered as a final purchase, like for example the purchase of an automobile, and that what national accounts call gross value added is in fact a net value added.

Finally, it is not uninteresting to recall one more that in his “General Theory” Keynes finds that counting what he calls the “user cost”, i.e. in fact depreciation, into the value of the product, results in making its amount dependent on the degree of integration of industry. This is the reason which Keynes refers to for excluding the user cost from the price of global supply and the value of the product, which is tantamount to rejecting the assumption that fixed capital transmits its value to the product! But he does indicate rightly that the total amount spent by buyers of final goods is gross of user cost. It is striking to note that this heterodox position of Keynes has been obscured, because it was very likely misunderstood by almost all of its commentators.

To understand Keynes's position, however, let us recall what we demonstrated in subsection 5.2 of chapter 11 (see pp. 220-221). To do that, it was sufficient to imagine a totally integrated economy, in which there would be no more than one capitalist enterprise. In this case there would be no need for any depreciation of capital to finance the purchase of fixed capital, since it would be produced by this enterprise itself and therefore would not appear on the market to be sold and bought by other capitalist enterprises. Capital goods constituting fixed capital would remain final goods, but not being subject to any exchange they would not even need to have a price. As for the sale of consumer goods, in the absence of capitalist consumption their price would just allow the recovery of all wages paid to all workers, without neither the possibility nor the necessity of including in their price any depreciation. It would be capitalist consumption alone which would imply a price higher than the level of total wages. It is therefore the existence of a multiplicity of capitalist enterprises that makes depreciation necessary, as a means of obtaining fixed capital through successive exchanges between the enterprises that produce it.
1.4. Fixed capital and some contradictions in economic theory

A wrong concept of fixed capital cannot but create contradictions in economic theory. In this connection, when assessing once more the question of the so-called transmission of its value to the product, one needs to recall a demonstration previously made by Bernard Schmitt and Alvaro Cencini, in a book published in 1976: "La pensée de Karl Marx - Critique et Synthèse ("Karl Marx's thought – Criticism and Synthesis"). This demonstration shows that the transmission of value of fixed capital is made possible only because of a faulty duplication. The $L_I$ value deemed to be transmitted by the amortized capital is indeed counted a first time in the value realized at the time of the production of this capital, when it is sold on the market. To count this value a second time in the value of consumer goods produced by the operation of this fixed capital through its interaction with labor, amounts to counting twice the value of a good which is exchanged only once.

The fact of counting twice the value of fixed capital goods that are realized only once, when these goods are bought by capitalists, is illogical. Since the value of fixed capital was realized in the period of its own production, it must not be counted a second time in the product of the current period, since fixed capital, once bought by capitalists and employed in the production process, does not come out to present itself again on the products market. As a result, contrary to what Marx thought, the value of the product of the period is identical to the value produced in the period, as long as there are no stocks of circulating capital.

So Adam Smith was right, when he wrote: "In the price of corn, for example, one part pays the rent of the landlord, another pays the wages or maintenance of the laborers and laboring cattle employed in producing it, and the third pays the profit of the farmer. These three parts seem either immediately or ultimately to make up the whole price of corn. A fourth part, it may perhaps be thought is necessary for replacing the stock of the farmer...and other instruments of husbandry. But it must be considered, that the price of any instrument of husbandry, such as a laboring horse, is itself made up of the same time parts; the rent of the land upon which he is reared, the labor of tending and rearing him, and the profits of the farmer, who advances both the rent of this land, and the wages of this labor. Though the price of the corn, therefore, may pay the price as well as the maintenance of the horse, the whole price still resolves itself, either immediately or ultimately, into the same three parts of rent, labor and profit" (Smith, 1776, p. 84: words in bold characters are from the author).

What Smith had understood was that it is not the old fixed capital which transmits its value or part of it (a value confused by Smith with a price, and thus made for of wages, rent and profit), to the new one (or to any other type of good), but the newly produced capital which adds its value - made also for Smith of wages, rent and profit, to the old one (the stock of existing fixed capital) either by replacing obsolete capital (in a self-replacing state) or by increasing this stock. That neo-classical economists do not understand that is not surprising, that Sraffa does not grasp that either is a little more surprising, but that Marx himself misunderstood this phenomenon is much more surprising, and might be due to the strength of the dominant ideology. As Marx and Engels wrote in a Critique of the German Ideology:
"The ideas of the ruling class are in every epoch the ruling ideas, i.e. the class which is the ruling material force of society, is at the same time its ruling intellectual force" (Marx & Engels, 1845, p. 21).

What must be understood is that once it has been produced and realized in the circulation
process corresponding to its production period, old fixed capital becomes an asset. At this
stage the incomes corresponding to its production have already been created and spent for
purchasing it in the circulation process. Therefore like any other second hand good, if it is
sold again on the market, it is not produced again, which will not create neither a new income
nor a new value, because the income obtained from this second sale by its seller will be
cancelled by the income spent by its buyer. This mere displacement of a commodity with a
money transfer in the opposite direction does not create any new income or value for the
economy as a whole, because only a new production process can do that.

**2. Again on the articulation between values and prices**

**2.1. The mode of determination and the significance of prices in both models**

The operation of the simplified model as described in chapter 11, with regard to the
realization of the product, has shown that the method of determining prices in section I differs
significantly from that in section II. It is because prices in section I are those of fixed capital
goods which are exchanged between capitalists only, and are thus fixed independently of the
distribution of the product between workers and capitalists: in other words the rate of surplus-
value, i.e. *k*, does not intervene in their fixing, contrary to what is the case in section II.

Indeed we had already seen that in section II the margin rate is $rac{k}{1+k}$, on the understanding
that under this simplified model the rate of surplus-value: *k*, as the ratio between $L_I$ and $L_{II}$
reflecting the distribution of labor between the two sections, also refers to what can be
considered as a particular set of techniques in use, i.e. to a state of technology. As
$$ \frac{k}{1+k} = 1 - \frac{1}{1+k} $$
it follows in passing that in section II the coefficient which plays the same
role as coefficient *u* plays in section I is $\frac{1}{1+k}$, which expresses the share of the product
obtained by workers in this section II, and that its inverse $1 + k$ is the multiplier by which $W_{II}$
wages need to be multiplied to obtain the price of the product in this same section.

In contrast, in section I there are in the general case two ratios, both independent of
distribution, which intervene in the setting of prices:

- The first one is ratio *a*, because this ratio refers only to the distribution of the value of fixed capital employed in the system between section I and section II;

- and second, in the general case, ratio *u* or rather a series of numbers that represent it
  (in the case of a multiplicity of separate ratios $u_i$ at each stage of purchases of fixed
capital within section I), and which express both the greater or lesser weight that fixed capital purchases have at each stage in relation to the fixed capital available, but also the greater or lesser power over the fixing of the selling price, because we must remember that 1 - u is a margin rate.

We also note that in the simplified model, for the same invariable value of the product of the two sections, i.e. $L_I + L_{II}$, and the same distribution of this product between workers, who obtain a value $L_{II}$, and capitalists, who obtain a value $L_I$ (equal to $kL_{II}$), one can have a multiplicity of prices of the global product, according to the values taken by parameters $a$ and $u$, since according to equation (23), above p. 215, we have: $Y = L_{II} \left(1 + 2k + k \frac{a}{u}\right)$.

In the model with capitalist consumption, the price of the product is given by equation (43) p. 240, and is clearly more complicated, since it is $Y = L_{II}[(1+\gamma)+k(2+\alpha+\gamma+\gamma^*+\alpha\gamma^*)]$, which shows even more that for a given value the price of the product can greatly change as a function of several variables which reflect the distribution of the product between the various stakeholders.

On its own, this demonstration of the variability of the price of the global product, as a function of the value of various parameters, shows that we cannot define these parameters as a function of prices, unless we fall into circular reasoning, which is precisely what happens with neo-classical theory. It is thus shown that the passage through values is an indispensable theoretical precondition to be able in a second step to think (at a conceptual level) about the nature and level of prices.

Incidentally, one of these parameters, parameter $u$, in the model with capitalist consumption, plays a special role in section I. It certainly acts as a coefficient expressing the share of available fixed capital obtained by the buyers of the capital in question. But from the sellers' point of view, this coefficient is nothing else than the inverse of coefficient $\frac{1}{u}$, i.e. the multiplier applied to wages in section I to obtain the selling price, as shown in table 6 of chapter 11. Moreover, the complement to 1 of $u$, i.e. $1 - u$, is none other than the margin rate, i.e. the ratio of profit over the price of the product, which corresponds in national accounts to the ratio EBITDA/value added. Seen from this angle, the magnitude of this $u$ coefficient expresses the balance of power which exists between section I capitalists in fixing the selling prices of the various means of production constituting fixed capital. Depending on this balance of power which governs the capacity of capitalists to influence this margin (the higher is the margin, the lower is $u$) this is the consumption of capitalists which is at stake, beyond the share of fixed capital obtained at each stage.

## 2.2. System of values and price system

Starting with the simplified model, the first of the lessons which can be derived from it on this matter is that the value system is a system that to some extent reflects the distribution of the
product between workers and capitalists because it gives the value of commodities going to both categories, but which before all reflects the structure of the productive system, through the influence on the one hand of the distribution of workers between the two sections producing consumer goods and fixed capital respectively, and on the other hand through the distribution of fixed capital between these two sections of the productive system.

The first type of distribution is expressed through the absolutely fundamental parameter *k*, since it is also the rate of surplus-value, at least within the framework of the simplified model. The second type of distribution is expressed by parameter *a*, which is the proportion of the total value of fixed capital which is used in section I, and refers to the structure of the productive system. From this point of view, this parameter corresponds to a state of technology, but it should be emphasized that in the context of a particular assumption adopted supra (see page 212), when *b* is replaced by *u* (or *u* is equal to *b*), this influence on prices comes from the fact that *a* is then also the homogeneous margin rate $1-u=1-b=a$ used by capitalists of section I in setting their prices. Finally, in this simplified model, the rate of surplus-value is endogenous and depends solely on the ratio between the amounts of average social labor employed in each of the two sections of the economy: the more average social labor is needed for the production of fixed capital, in proportion to that of consumption goods, and the higher is this rate of surplus-value.

This observation helps us to understand that surplus-value is a social and global phenomenon, which explains why there is only one rate of surplus-value, which must necessarily be the same for all workers, whatever their wage level, or the section of the productive system, or the firm, where they work in. It is so because exploitation in its economic sense is not an individual phenomenon. In other words there cannot be different rates of surplus-value $k_i$ or $k_{ci}$. Indeed if it were the case this would come down to imagining that workers would only buy the commodities produced by the firm which employs them, an assumption which would be completely absurd. For instance trying to calculate a distinct rate of surplus value in section I would imply that workers in this section would buy fixed capital, which would be a pure nonsense!

What both models have shown also is that the price system associated to the system of values validates the latter by ensuring the reproduction of the system at the level of circulation, i.e. through the realization of the product of the two sections, even when there is capitalist consumption. The price system allows this reproduction to take place by ensuring the distribution of the value of commodities produced, on the one hand between workers and capitalists, and on the other hand between capitalists of the two sections. It thus allows the realization and the distribution of fixed capital between both sections, while ensuring that this distribution is maintained, through the role played by parameter *a*. The price system therefore has a dual logic: a logic of distribution of the product at the stage of circulation and a logic that could be called technological, but which over-determines that of distribution. From this point of view, prices as described and discussed here, as monetary prices derived from a transformation of values, reflect the macroeconomic constraints expressed through the action of these different parameters.
Another lesson that emerges from this analysis is that the value system and the price system are closely related, and that both are indispensable to the understanding of the other: all variables that we examined so far, whether expressed in values or in prices, are expressed in terms of the fundamental parameter *k*, which we already called the system basic rate of surplus-value, and which accounts for the distribution of workers and value produced between the two sections of production.

It is therefore clear that the value system is the underpinning of the price system, and frames the magnitude taken by its variables, even if it is true that there is a feedback from the price system on the value system as soon as the consumption of capitalists comes into play, through the intervention of parameters *c* and *c**, which belong initially to the world of prices. The role played by these two parameters testifies to the fact that in the capitalist mode of production the objective of capitalists is not only to maintain themselves as such, thus perpetuating this mode of production through a fixing of prices which allows them to recover the entire fixed capital produced at each production cycle, but that their ultimate objective, through the perpetuation of their ownership over the means of production, is in fact to appropriate as substantial a share as possible of the production of consumption goods.

This seems simple at first glance for capitalists of section II, through the fixing of the price of consumption goods at a level which allows them first of all to fix the amount of surplus-value, while prefixing the share of the production of consumer goods that capitalists as a whole are going to appropriate. It should be remembered that in the day-to-day running of developed capitalist economies this is easy for producers of mass consumer goods, which in most sectors find themselves in the position of oligopolistic "price-makers" facing a multitude of "atomized" consumers. In fact it is less simple than it could seem for capitalists of section II because this initial global share of consumption goods going to capitalists will have itself to be shared with capitalists of section I, as we shall see in sub-section 3.1. below.

These considerations allow us to formulate a new principle regarding the nature of prices.

**Principle 28:** Because of their close connection to money values, which themselves reflect the conditions of production, it is not wrong to consider prices as also reflecting these conditions, and thus as production prices. However this is a very partial view of reality. First because money values themselves are depending on the distribution of wages between workers. And second because their fixing is linked to the extraction of surplus-value (for section II prices), and to the distribution of this surplus-value between capitalists (for section I prices). As a result, prices must be further considered as distribution prices, being understood 1) that the understanding of distribution involves many factors, a number of which have nothing to do with economy as such, because they are of a sociological, ideological, institutional and political nature, and 2) that distribution itself must be seen ultimately as a distribution of commodities.
**3. The conditions of profit formation**

**3.1. The dual regime of setting shares of profit**

Through the operation of the simplified model, let us recall that the mechanism explaining the
realization of the product and profits in section I was identified as similar to the Keynesian
principle of the "widow's cruse", meaning that it is the expenditure of profits that creates
profits and makes it possible to realize the product of section I. But this was in fact a
generalization of Keynes's ideas, which were formulated initially to apply to capitalist
consumption only, i.e. to capitalists spending on consumption goods.

As we already indicated in subsection 5.4. of chapter 11, this simplified model allowed us to
understand that profits are the result of a double transfer:

* a first transfer, which takes place on the occasion of the expenditure of wages by workers of the two sections, for the purchase of consumer goods from the capitalists of section II. It is through this first transfer that surplus-value is extracted, once and for all, in an amount which is fixed and no longer liable to change. This transfer simultaneously fixes the amount of monetary profits (i.e. $L_I$) for capitalists of section II.

* a second transfer, of a very different nature because it only involves capitalists themselves, and which is carried out on the occasion of the purchase by capitalists of section II, from those of section I, of the fixed capital which they need to produce final consumption goods. This purchase has no influence on the amount of surplus-value, which has already been determined, but it fixes the distribution of this total surplus-value between capitalists of the two sections. The share going to capitalists of section II is $(1-a)L_I = bL_I$, as we saw in chapter 11, and that going to capitalists of section I is $aL_I$, which also corresponds to the amount of monetary profits going to the capitalists who in section I ensured this sale. This first transfer to section I will then be followed by successive transfers (logically), within section I, transfers which will ensure the distribution of this surplus-value and corresponding profits between capitalists of this same section.

Now, and we will have the opportunity to come back to that, the first transfer is not in itself problematic, at least as a transfer, because it is a transfer between workers who are price-takers only and capitalists who are price-makers. On the contrary, transfers between capitalists as transfers for the distribution of a prefixed amount of surplus-value, are a zero sum game, and as soon as capitalist consumption is introduced, their results, outside the model and in the real world, can be problematic. Before developing this point, we must emphasize the fact that we have therefore two regimes for the realization and determination of profits.

Indeed, and without returning to all the details of the profit-making process highlighted in previous chapters, it must be stressed that the double system of transfers comes down to recognizing that there are two distinct regimes for the realization of profits.
The first regime concerns the constitution or creation of profits, and corresponds to their initial realization in section II. At the risk of repeating ourselves, it is directly linked to the fact that workers by definition buy consumption goods only, and therefore it is from the fixing of their price that the amount of surplus-value derives and materializes in the form of section II profits. These profits are hence nothing else than surplus-value realized in its monetary form through a transfer resulting from the expenditure of money wages. In passing, this explains why Marx's formula expressing the overall rate of profit in terms of values remains valid for the determination of the rate of profit in terms of prices in this section.

However, when we introduce capitalist consumption in the model, things become more complicated. Indeed this first transfer is a kind of priming of the pump, because it does not allow for the full realization of surplus-value under the form of monetary profits in this section, where only a part of all goods produced have been sold to workers, by definition, since this is a condition for capitalist consumption. This full realization can only be completed when all consumption goods are sold, including those bought by capitalist of both sections. This implies that not only capitalists of section II, but also capitalists of section I must realize their profits, from which they will buy consumption goods. These last profits will start being realized when capitalist of section II use their own profits to buy fixed capital goods, which leads us to the second regime of profit realization.

The second regime concerns the distribution of surplus-value under the form of pre-existing profits, through their investment in the purchase of fixed capital, by capitalists of both sections. These purchases allow for the realization of additional profits in section I through the fixing of the price of fixed capital goods, and for the distribution of these profits and means of production among capitalists themselves. This process starts with a first distribution between capitalists of section II producing consumption goods and those of section I producing fixed capital, when the former buy fixed capital from the latter, and continues with the distribution of profits and fixed capital between capitalists of section I themselves. The logically "successive" exchanges of these means of production, through the "successive" spending of profits, ensure this distribution, while respecting the "technological" constraint represented by parameter *a*.

However the introduction of capitalist consumption in chapter 12 has shown that these two regimes are linked, because as soon as workers cease to be the only buyers of consumption goods, the interaction between capitalists of both sections ceases to be limited to the purchase of fixed capital by capitalists of section II. Not surprisingly, since it was Keynes's initial idea, the widows' cruse mechanism plays its role here: the spending of profits on consumption goods indeed results in new and additional profits in section II. But there is a limit on these profits and on capitalist consumption, which is the amount of surplus-value originally extracted from workers through the pricing of consumption goods, which means that capitalists of both sections have to share a prefixed quantity of these same goods: it is the quantity corresponding to the value of consumption goods not bought by workers. Rather similarly, the share of section II capitalists in consumption goods is also prefixed as soon as they have bought the fixed capital which they need from capitalists of section I.
This explains, as chapter 12 also showed, that the realization of profits in both sections is in fact more complicated than it would seem at first, because it implies a series of interactions between capitalists of both sections. In other words, the fact that the amount of profits of section II capitalists is theoretically prefixed, as soon as workers are paid and prices of consumption goods are fixed, does not mean ipso facto that all of these profits are realized. For that to happen, they need also to use their own profits to buy their own consumption goods, and sell the remaining part of consumption goods to capitalists of section I. In turn capitalists of section I need to buy their share of fixed capital (supposed to be predetermined by technological constraints) and the remaining part of consumption goods.

At the completion of this interactive and iterative process all commodities of both sections have been sold and at the same type all profits have been spent, so that there no longer exists any monetary profits in the system, which constitutes a necessary condition for the realization of the totality of surplus-value, through its distribution to its capitalist beneficiaries. This surplus-value, extracted under the monetary form of profits, ultimately takes the form of consumption goods and fixed capital appropriated by capitalists. Profits indeed disappear under their monetary form, because – if the system works smoothly, through their spending on commodities these profits ultimately go back to the firms which had initially borrowed corresponding amounts of money, and must necessarily use them to repay the banks, an action which destroys the amount of money previously created for the payment of wages at the beginning of the production cycle.

The conclusion that emerges from this analysis is that in any case there is an irreducible heterogeneity in the way the shares of profits and profit margins between the two sections of the productive system are realized and determined. As we shall see latter, this cannot but create a heterogeneity in the rates of profits proper, and in any case has the potential to create conflicts between capitalists. All the more so that in the real world spending on final goods, i.e. fixed capital and consumption goods, are not the only ones made by firms, which also buy intermediate goods, as we shall see in next subsection.

## 3.2. The conflict between capitalists for the distribution of surplus value

What clearly comes out from the analysis resulting from the model with capitalist consumption, introduced in chapter 12, is that the question of the appropriation of consumption goods by capitalists does not depend only on the price of these goods, but lies also behind the fixation of the price of fixed capital goods. Indeed surplus-value extracted in the form of profits in section II becomes immediately the subject of a dispute as to its distribution among capitalists themselves, depending on the level of prices of fixed capital. This conflict aims first at fixing the share of consumption goods accruing to capitalists of section II, compared to that accruing to capitalists of section I. It aims secondly to fix the share of capitalists producing fixed capital for those of section II compared to the other capitalists of section I, and so on at each stage of investment spending within section I.

However, this conflict cannot affect the amount of surplus value. Indeed parameter $c^*$, which appears in the first row of the table in chapter 12, and accounts - as defined, as being the share
of consumption of capitalists of section I selling to capitalists of section II, contained in a
price $\frac{1}{1-c^*}$, only defines the price of fixed capital, and has no influence on the price of
consumption goods. It is the relative market power of the first ones over the others that will
govern the fixation of $c^*$, which in a situation of fragmentation of this power could moreover
rather be conceived as a set of $c_i^*$ elements, each one with its own different magnitude.

Going upstream in the productive system, fixed capital suppliers are more likely to be reduced
to the sole role of subcontractors, and it is also easy to understand that small producers of
specific types of fixed capital are by nature in this category, in the face of oligopolistic groups
of section I firms producing on a larger scale more standardized goods, which can therefore
be used interchangeably in section I and section II, and whose market is much bigger. The
situation may be the same for producers of intermediate goods.

Up to now indeed we made the assumption that each section of the productive system might
be defined as the integration to final producers of all enterprises producing intermediate
commodities used in the production of final commodities split between consumption goods,
on the one hand, and fixed capital goods, on the other hand. If we abandon this assumption
that the productive system is integrated, then in each supply chain, corresponding to the
production of either a consumption good or a fixed capital good, we have a number of
enterprises selling intermediate goods that are more and more transformed (when we go
downstream in the system) to other enterprises, along the chain going from primary
commodities to commodities sold to final producers, then to wholesalers and ultimately to
retailers. Each one of the exchanges which takes place all along this chain comes as a
deduction of the potential profits of the buyer, and simultaneously as an increment to the
profits of the seller. This explains why these exchanges are potentially conflictual ones. In the
real world these conflicts are usually resolved by negotiations, which most often end up by
the signature of a contract between the parties involved.

These situations are not at all theoretical, and to give but one example of such a conflict in the
real world, we can briefly mention the case of the food sector in France. As reported in “Le
Monde” newspaper, in a 2017 article by Laura Motet, each year there is a kind of price war
between mass-market retailers and producers in this food sector. “It takes the form of
negotiations between producers, manufacturers and retailers to negotiate a fair sharing of
value added. These negotiations between mass-market retailers and their suppliers, whether
they are small-scale producers in cooperatives or large international industrial groups, start in
October and must normally be concluded at the end of February. They are most often
conflictual, and must fix for the following year the tariffs of the products bought by the big
mass-market retailers to garnish their shelves” (Motet, 2017, October 11).

“At the outset, suppliers are obliged by law to indicate the "average forecast price" of the
main agricultural raw materials they use. However these negotiations are not only about
prices, but also about the layout of products on the shelves. In a context of strong competition
between manufacturers, being present at eye level or at the shelves head is crucial.
Distributors and suppliers sometimes fail to reach an agreement before the last day of February, which results in products being then removed from the store. But some distributors practice these dereferences even before, during negotiations, with a view to show the supplier the shortfall if the agreement is not signed, and to induce him to lower its price" (ibidem).

"Beyond these illegal practices, the stumbling block of these negotiations remains the determination of the sale price. One week before the end of the 2017 negotiations, only a minority of suppliers had agreed with distributors. "Signing faster does not mean signing for good conditions unfortunately for some companies [...]. Some companies give in or sign because the balance of power with their client is particularly unfavorable", says the National Association of Food Industries. According to suppliers, distributors do not intend to sign these agreements without obtaining a tariff reduction. A decrease which is not always in accordance with the very volatile price of raw food materials" (ibidem).

Recognizing the complexities of the real world, on which we tried to shed some light, gives us the possibility to derive a new principle:

**Principle 29:** Prices, in so far as they are distribution prices, are the object and the resultant of multiple conflicts, which may or may not be arbitrated by the State. They ensure the continuity of the capitalist mode of production by ensuring the distribution of fixed capital among capitalists. But even more they also ensure the collection and distribution of consumption goods among these same capitalists. They make us realize that the ultimate goal of capitalists is not only the accumulation of fixed capital, but also the accumulation of consumption goods.

Apart from these conflicts localized along supply chains, a particular case of conflict over the sharing of surplus-value has to do with the existence of banks, and will be addressed now.

**3.3. Sharing surplus-value with the banking system**

Within the framework of the analysis conducted so far, banks are a particular category of capitalist enterprises, which primarily sell the services of money creation and financial intermediation. Since these activities are carried out through lending, their main remuneration is obtained by charging an interest rate to their borrowers.

It goes without saying that in this analysis the interest rate by itself has nothing to do with the profit rate, because setting it is quite specific to the monetary and financial sphere, and this is not the object of this book. The global financial crisis of 2008-2009 and the developments which have followed have amply showed that the interest rate is certainly not a price that can be purely determined by supply and demand, if only because there is no exogeneity of the money supply. Central Banks intervention in the wake of this crisis has also showed that the interest rate is before all institutionally determined. It should be clear therefore that the rate of interest and the rate of profit are distinct variables, whose evolution can follow vastly diverging paths.
However, it is striking that this position is far from obvious for many economists. As a good example, we can cite a recent IMF working paper by Goes: “Testing Piketty’s Hypothesis on the Drivers of Income Inequality”, where all calculations are made by squarely identifying the rate of return on capital with the long term rate of interest. Indeed Goes indicates: “ To derive the second variable of interest – namely, the real return on capital net of real GDP growth – I take yearly averages of nominal long-term sovereign bond yields, calculate the post-tax nominal rates by deducting corporate income taxes and subtract from them annual percent changes in GDP deflators and real GDP growth” (Goes, 2016, p. 6)! At least this author recognizes that “the choice of sovereign bond yields as a proxy for returns on capital is not self-evident” (ibidem). When one knows that in the last ten years in most developed economies the gap between both rates has surely exceeded 10 %, with negative rates on sovereign bonds yields adjusted for inflation and GDP growth, all this is nothing but a theoretical aberration!

Going back to interest rates, and from the point of view of individuals, interest rate paid to them on deposits can be considered with Keynes as the reward for parting with liquidity, which has nothing to do with a rate of profit. If we adopt the point of view of banks the interest rate charged to borrowers is the price of a service which to be ensured implies to pay a lower interest rate to lenders or depositors, and both rates are equally independent of the rate of profit. Their difference is usually considered as the price of the services of money intermediation (and creation). The difference between the rate paid to banks by borrowers and the rate actually paid to depositors represents what national accountants call charges for financial intermediation services indirectly measured<fnref n="12" />. We can call it more simply the price of banking services.

This price corresponds to what US banks call operating revenue, British banks operating income and French banks net banking income. It can be considered as a product, in this case the “financial and banking services of intermediation and money creation”. The value of this product corresponds, as for the rest of the system, to the amount of money wages in the banking sector, if it is consolidated as an integrated sector. Indeed these services like any others have a cost: banks have to pay wages to their workers, and buy intermediate commodities. Thus the difference between the price of these services and the wages paid to ensure it is like profits a transfer income.

This gross profit of the banks, that is to say the difference between this operating revenue or net banking income and the wages of the sector, is of the same nature as the profits of the rest of the system, and is constituted in the same way through the sharing of surplus-value. It is easily understandable that if the profits of the banking system tend to increase more rapidly than other profits, this increase is necessarily obtained at the expense of the rest of the productive system, and is in no way additive to the rest of profits. So there is also a conflict between capitalists of the banking and financial sector and capitalists of the non-financial sector for the sharing of surplus value.

<footnote n="12">¹² In practice things in national accounts are more complicated, because of the intervention of a reference rate of interest, but there is no need to enter into such complications within the framework of this book.</footnote>
It must also be understood that, if they have to be recorded within the framework of our models, and like for other types of commodities which are sold to workers as well as to capitalists, these financial intermediation or banking services must be split between section II and section I. In any case these activities, which are indispensable for production to be carried out, can be considered as productive activities, and as such are creating value.

However, since the beginning of the 80's (in fact since 1978), there has been a constant trend of deregulation in the USA which allowed banks and financial institutions to engage more and more into another type of activities, which is usually called investment banking. On the broad question of deregulation, one can refer to a short but well documented and synthetic article by Sherman, from the Center for Economic and Policy Research: "A Short History of Financial Deregulation in the United States" (Sherman, 2009, pp. 1-15).

As for investment banking, this activity has two main lines of business, called the sell side and the buy side. The "sell side" involves trading securities for cash or for other securities (e.g. facilitating transactions, market-making), or the promotion of securities (e.g. underwriting, research, etc.). The "buy side" involves the provision of advice to institutions that buy investment services. Up to 1999, there was in the USA a separation between investment banking and commercial banks which was repealed in 1999 by the _Gramm-Leach-Bliley Act_. A similar trend of deregulation happened in other advanced economies. This allowed a huge development of these activities by commercial banks, which involved securitization, the creation of sub-primes, etc. All these new developments ultimately provoked the global financial crisis of 2008.

It is important to understand that most of the huge profits made in this business, before it collapsed, did not come from any production at all, but from the exchange of already existing financial assets., an activity which is indeed pure speculation, i.e. the purchase of assets (commodities, _goods_, or _real estate_) with the hope that it will become more valuable at a future date. In finance, speculation is also the practice of engaging in risky financial transactions in an attempt to profit from _short term fluctuations_ in the _market value_ of a tradable _financial instrument_ - rather than attempting to profit from the underlying financial attributes embodied in the instrument such as capital gains, dividends, or interest.

If we mention it, this is to state that speculation as such creates absolutely no value. In fact it does not create any net profits either, because the corresponding activities concern existing assets, whose sale against money only symmetrically moves the property of these assets from the seller to the buyer, and moves money in the opposite direction (like for any exchange of second-hand goods). Therefore any profits made from this activity by an economic agent cannot constitute a net income at macroeconomic level, because they correspond to a symmetric reduction of income for another agent. When these profits are spent on real goods, they just reduce the remaining amount of existing surplus-value which has to be shared by all other capitalists.

More generally, surplus-value realized by capitalists in the financial sphere cannot but reduce the amount of surplus value realized in the sphere of real production of goods and services. It
is therefore easy to understand that the financialisation of capitalism which started at the beginning of the 80s in most of advanced capitalist economies has resulted over the years in a reduction in the share of profits going to capitalists in the sphere of real production, thus reducing their capacity to invest.

All these elements give us now the possibility to state several new principles concerning the role played by the banking sector (principle 30), the conceptual status or nature of interest rate (principle 31), the nature of money (principle 32) and finally the status of banking services (principle 33).

**Principle 30:** The banking sector plays a fundamental role in the capitalist mode of production, by creating the money which among others is indispensable for the payment of wages. The service that the sector renders, by providing this money as well as the service of financial intermediation, has like all services a value measured by the amount of average social labor time spent in the sector, and a money value, measured by the amount of money wages paid to the sector' workers, who contribute like all workers to the creation of surplus-value. The macroeconomic cost of the services of money creation and intermediation is made of wages and of a cost which is the creditor interest rates paid to depositors of money in the banking sector. To this cost must be added the profits of the banking sector, to obtain the price of the service.

**Principle 31:** Like rent is the price paid to or income received by the owners of non-produced goods for obtaining the right to use them during a defined period, creditor interest rates must be considered as the price paid to or income received by the owners of money assets so that banks can use these assets during a defined period. This is why interest rate can be viewed as the price received for parting with liquidity. Interests paid by borrowers are similarly the price paid by them to banks to be able to use defined amounts of money during a specified period, and which constitutes the banks gross income. It follows that interest as an income remunerates the property of money assets, owned either by depositors or by banks. Therefore, like profits or rents, interests are a transfer income.

**Principle 32:** Formally money should be considered as produced by banks, to some extent ex nihilo, because it is not the result of a transformation. But it must be considered nevertheless as non-produced, because – like land for instance, it does not belongs as such to the production process, where it does not result from a transformation and is not itself transformed. It is so because money is not a good that could be sold against itself, which would be a nonsense. Only the right to use it for a definite period is sold (also like for land), against payment of an interest. As such money cannot be considered neither as a final good, which could be consumed or stored, because at global level it always has to be repaid, which ultimately destroys it, nor as an intermediate good or service, which would disappear in the production process.
**Principle 33:** Apart from various fees, the price of the services of money creation and financial intermediation rendered by banks corresponds to the debtor interest rates charged by banks to borrowers. Their overall amount during a given period of time is part of the total price of the product of this period. It includes wages paid in the banking sector, i.e. the money value of bank services, creditor interests paid to depositors and bank profits. Both creditor interests and bank profits are part of global surplus-value. Bank services can be sold both to firms and individuals, be they capitalists or workers. When they are sold to firms, they play the same role as intermediate commodities, and their price becomes a part of the price of the final product, either of consumption goods or fixed capital goods, depending on the section which the firms are part of. When they are sold to individuals, they are part of their consumption, and thus play the same role as consumption goods, of which they are a particular type.

Competition among capitalists for the appropriation of the largest possible amount of surplus-value, especially in an economic world dominated by a limited number of huge multinational firms, most often oligopolistic and struggling to dominate world markets, leads us to an image of the economic world which is far away from the fairy tale behind the neo-classical paradigm. What kind of micro-economic price theory could correspond to this type of situation is the question which we will briefly address now.

# 4. A truly micro-economic price theory

## 4.1. The circularity of neo-classical price theory

Let us recall that neo-classical theory conceives exchange as a barter trade between economic agents which are endowed with different goods before exchanges take place. Supply and demand of these goods depend on the subjective utility which they attach to these goods. Exchange is conceived as an equivalence relation, and the determination of all prices, considered as exchange ratios, takes place on the market when these prices ensure that equilibrium - defined by the equality of all supplies and demands, is reached simultaneously for all goods.

In this paradigm prices are relative prices, defined in terms of one of the goods considered as the numeraire. The theory is however circular, which invalidates it, because the existence of this numeraire, in the form of one of the goods chosen as a standard or measurement unit, must be postulated before exchanges take place. This is indeed a logical precondition, made necessary to allow an auctioneer to announce a first price system, on the basis of which a trial and error process will take place. This process is supposed to lead to an equilibrium allowing actual exchanges to be carried out. It is thus necessary that a first price system exists, even before prices are determined...This is equivalent to the assumption that all economic agents can express the subjective utility that they attach to all goods in the same measurement unit, before exchanges take place. The circularity of such a reasoning shows that exchange alone is unable by itself to provide the basis for a coherent theory of value and prices.
This implies that the nature of values and prices must be defined independently of exchange, which is precisely the approach which has been followed so far: values are defined at the level of production, and prices at the level of circulation, assuming the existence of money as a non-commodity, and within a set of macroeconomic constraints which are indispensable for the reproduction of the economic system.

As regards now a theory of the determination of micro-economic prices, understood as a one by one determination of the price of each single good (and not as their simultaneous determination, like in neo-classical theory), it must necessarily take into account, as its basis, all of the global constraints which have been examined so far. Such a micro-economic theory is not the object of this book, but we shall nevertheless touch upon a few requirements which it should meet, restraining ourselves to laying just a few milestones, and referring specifically to recent microeconomic theories.

## 4.2. Exchange as the expression of a balance of power

Prices of commodities and distribution of incomes are two sides of the same phenomenon, as we believe it has now been demonstrated, because exchange is not only a transfer of a commodity from a seller to a buyer, but at the same time a transfer of money from the buyer to the seller, which reduces the income of the buyer and increases the income of the seller. It is therefore no wonder, when their income is at stake, that the relationships between buyer and seller may express a balance of power, at least on each occasion where it is possible to discuss or influence the price at which actual exchange is going to take place.

We just showed in the last subsection that this is generally the case for the price of fixed capital, of which the various components are exchanged between capitalists, where there are no so many agents involved. On the contrary, it is most often not the case for consumption goods, which are sold in huge quantities to myriads of consumers at fixed prices. This explains that workers usually cannot discuss the price of the commodities that they buy, which is a fundamental phenomenon for the extraction of surplus-value.

However, workers are usually able individually or through their trade unions to discuss the level of their money wages. This means that workers have the possibility through such a negotiation to influence the amount of surplus-value. It must be understood nevertheless that any gain obtained on this front can easily be reversed by an increase in the price of consumption goods. In passing we may note that we touch here upon a mechanism which might well be at the heart of a theory of inflation, but we shall not expand on this question, since it is not the subject of this book.

Moreover, we must take into account the fact that these activities of buying and selling are decentralized within the economic system, and as soon as we abandon the wrong idea of the existence for all markets of a Walrasian auctioneer, this fact has very important theoretical consequences. Indeed this simple observation means that one good can have several prices at the same time. We already saw in the previous chapter on the theory of rent that one same good could have a number of different production costs, or money values, due to the
heterogeneity of the conditions of production. Not only because of the existence of
unproduced means of production, but also because of the multiplicity of producers and the
diversity of these conditions of production, even in the absence of unproduced goods, these
phenomena being at the heart of a coherent theory of rent and quasi-rent, on the one hand, and
of a differentiation of profit rates, on the other hand.

We must now acknowledge that, as well as there is a great heterogeneity and diversity in the
conditions of production, there is also a great heterogeneity and diversity in the conditions of
circulation and exchange. The same good can therefore have different prices at the same time
depending on a multiplicity of factors, such as the type of firm or store from which it can be
purchased, its location, the quantities purchased, etc....

This multiplicity of prices, even for strictly identical goods, is a well-known fact that can be
observed by anybody in the real world, and what a theory - even economic theory, should
explain, is the real world and not a world of fantasies. Let us recall that Wittgenstein rightly
said that “the world is everything that is the case” and that “the totality of facts determines
both what is the case, and also all that is not the case” (Wittgenstein, 1921, p.1, propositions 1
and 1.12). Of course this conception of prices completely invalidates most of orthodox
economic theory, to begin with neo-classical theory, because this theory is based on the
contrary on the explicit or implicit postulate of unicity of prices, according to which one good
can have only one price. It is a precondition to write the equations of general equilibrium or
even Sraffa’s equations, which would otherwise be totally indeterminate.

Besides, this observation of the multiplicity of prices for one good is perfectly coherent with
the fact that all prices which have been dealt with so far are not micro-economic prices in the
sense of prices of single goods, but are always statistical averages between a multiplicity of
prices. This is the case for all the variables which we introduced so far in our models.
Especially, the fundamental labor price $\bar{w}$ is itself the average nominal wage rate of millions
of workers. The prices of each section of the productive system, i.e. the price of consumption
goods $P_{II}$, produced by section II, as well as the price of fixed capital goods $P_I$, are both an
average of prices of thousands of individual goods. Recognition of this fact leads to a new
basic principle:

**Principle 34:** A macroeconomic theory is a theory where all prices are statistical averages, and consequently where the magnitude of all "real" variables, since they are measured in terms of prices of their constitutive commodities, is itself a statistical average. A microeconomic theory of prices should therefore restrain itself to the disaggregation of these statistical averages, with a view to understanding the formation of the price or multiplicity of prices of each particular commodity included in these same averages.

Arrived at this point, there are not many economic theories which can correspond to our
theoretical background and qualify to explain the determination of micro-economic prices.
However, owing to the fact that once the macro-economic setting is in place each particular
price, at micro-economic level, must reflect in one way or another a particular balance of
power, and that in the real world prices are often determined through negotiations which usually end up by the signature of a contract, it seems to us that the question of pricing at micro-economic level might be addressed, at least in part, by what is usually known as the theory of contracts, which is often considered as being itself a part of the theory of incentives.

The theory of incentives is based both on the theory of information and on the theory of games. The pioneers of the field, Jean-Jacques Laffont and David Martimort, present the most thorough yet accessible introduction to incentives theory to date, in their book published in 2002: “The Theory of Incentives. The Principal-Agent Model”. They show that the mere existence of informational constraints may generally prevent the principal from achieving allocative efficiency. Since in the real world informational constraints are everywhere, this theory is in itself sufficient to ruin the neo-classical paradigm and its so-called theory of prices which – as we already pointed out, is anyway logically inconsistent because of its circularity.

Although Laffont and Martimort do not seem aware of this last problem, they indicate in the introduction of their book that “general equilibrium theory proved apt to powerful generalizations and able to deal with uncertainty, time, externalities, extending the validity of the invisible-hand as long as the appropriate competitive markets could be set up. However, at the beginning of the seventies, works by Akerlof (1970), Spence (1974), and Rothschild and Stiglitz (1976) showed in various ways that asymmetric information was posing a much greater challenge, and could not satisfactorily be imbedded in a proper generalization of the Arrow-Debreu theory. The problems encountered were so serious that a whole generation of general equilibrium theorists gave up momentarily the grandiose framework of GE to reconsider the problem of exchange under asymmetric information in its simplest form, i.e., between two traders, and in a sense go back to basics. They joined another group trained in game theory and in the theory of organizations to build the theory of incentives, that we take as encompassing contract theory, principal-agent theory, agency theory and mechanism design” (Laffont and Martimort, 2002, p. 13).

From this quote it is perfectly clear that a theory like the theory of incentives obviously does not aim at determining all prices simultaneously, as neo-classical theory tries to do – without succeeding in this endeavor anyway, and is on the contrary a true microeconomic theory, as we defined it, which seems to be compatible with the analyses developed so far. The theory of incentives is however not alone to qualify as such. For instance “mechanism design”, which is the last theory cited above, deals with incentive-compatible mechanisms, which satisfy certain incentive constraints. The Nobel Prize lecture by Roger B. Myerson precisely addresses the perspectives on mechanism design in economic theory (Myerson, 2007, pp. 320-341).

Besides that, another quite interesting microeconomic theory, which was recently developed, is known as “evolutionary microeconomics”. This is also the title of a book by Jacques Lesourne, André Orléan and Bernard Walliser, where the authors clearly state that their approach is differentiated from the Walrasian model, when they write: “the idea underlying the evolutionary approach is to abandon the hypothesis of centralization, which lies at the heart of Walrasian “tatonnement”, and to replace it by decentralized processes of information,
negotiation and exchange. Here we are poles apart from the theory described above: in our
simple market agents pair up randomly, and can contract, if they so wish, at the prices they
negotiate, even outside a situation of equilibrium. *A priori*, therefore, there is nothing in such
a structure to ensure price unicity. Each elementary transaction can take place at its own
specific price. Contrary to the previous approach, price unicity, if it appears, must be
interpreted as an emergent property, as a pure product of competitive forces, and not as the
expression of a *prior* postulate provided by the hypothesis of the auctioneer" (Lesourne,
Orléan, Walliser, 2006, pp. 48-49).

Whatever the elements of understanding that both the theory of incentives or evolutionary microeconomics may bring about as regards the determination of individual prices, it remains that to have a full understanding of a particular price and its evolution in the real world may also require to mobilize other fields of social science, because many prices if not all of them cannot be considered as the result of purely economic mechanisms. Indeed the level of a particular price may be also the outcome of sociological, cultural, ideological or even political phenomena.

Finally, accepting the multiplicity of prices, both in reality and in theory, makes it easier to
understand that similarly there is a multiplicity of profit rates among firms which produce a
particular commodity, as well as among the subsectors which produce different commodities,
or between section I and section II. This means that the rate of profit, which plays quite an
important role in most economic theories (be they neo-classical, Sraffian or Marxist) should
be viewed much more as a statistical average and a theoretical concept, which reduces and
simplifies the complexity of the real world, like an enlarging zoom, which loses track of
details, than as a tangible reality. In other words the average rate of profit, although it is an
intellectual reality, something that Althusser would have called "concrete in thought", has no
material existence as a tangible element of the real world, which would be an indispensable
element of any price, and could be empirically observed. Such a view cannot but have a
bearing on what should be the aim of microeconomic theory, which we can translate in a new
principle. Neither this average rate of profit should be linked in one way or another, to the rate
of interest, which is a very different variable.

**Principle 35:** The aim of microeconomic theory should be to understand and explain the divergence between individual prices and statistical averages. This should be done first for the various prices of a same commodity, which come from differences in the conditions of production and in the rates of profit, as well as in the level of rents. This should also apply to the explanation of the difference between rates of profit affecting the production and distribution of different commodities.

Whatever the way the origin and nature of profit is explained among various economic
theories, there seems nevertheless to be a consensus among many economists of various
schools of thought, to consider that the question of the level and evolution of the profit rate is
closely related to the reproduction of the economic system and the existence of crises. For this
reason, these points are worthy of further consideration. However the rate of profit is not a
price, but the ratio of an income rewarding the property of fixed capital to the value or price
of this same capital. Since the present third part of this book is devoted to distribution and prices, we consider that these points need therefore to be discussed in a new and last part of this book, devoted to the rate of profit and the reproduction of the economic system.

## References

Goes, Carlos (2016). Testing Piketty's Hypothesis on the Drivers of Income Inequality: Evidence from Panel VARS with Heterogeneous Dynamics. *IMF Working Papers*, WP/16/160, pp. 1-27.

Keynes, John Maynard (1936). *The General Theory of Employment, Interest, and Money*. Cambridge (UK): Cambridge University Press.

Laffont, Jean-Jacques and Martimort, David (2002). *The Theory of Incentives. The Principal-Agent Model*. Princeton: Princeton University Press.

Lesourne, Jacques, Orlean André, Walliser, Bernard (2006). *Evolutionary microeconomics*. Berlin, Heidelberg, New York: Springer-Verlag.

Marx, Karl (1885). *Capital: A Critique of Political Economy. Volume II - Book One: The Process of Circulation of Capital*. Edited by Friedrich Engels. Source: First English Edition of 1907. Marx/Engels Archive [online]. Available at: https://www.marxists.org/archive/marx/works/download/pdf/Capital-Volume-II.pdf
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Marx, Karl, & Engels Frederick (1845). *A Critique of the German Ideology*. Source: Progress Publishers, 1968. Marx/Engels Internet Archive [online]. Available at: https://www.marxists.org/archive/marx/works/download/Marx_The_German_Ideology.pdf
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Motet, Laura (2017, February 26, updated October 11). *Etats généraux de l'alimentation : comprendre la guerre des prix entre grande distribution et producteurs* (General conference on food supply: understanding the price war between mass distribution and producers). *Le Monde* [online edition]. Available at: https://www.lemonde.fr/les-decodeurs/article/2017/02/26/guerre-des-prix-tensions-dans-les-negotiations-entre-grande-distribution-et-producteurs_5085749_4355770.html
Accessed 3 Sep 2018

Myerson, Roger B. (2007). Perspectives on mechanism design in economic theory. Nobel Prize lecture. Chicago: Department of Economics, University of Chicago.

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Schmitt, Bernard, and Cencini, Alvaro (1976). *La pensée de Karl MARX - Critique et synthèse* (The thought of Karl Marx - Criticism and synthesis). Albeuve (Switzerland): Castella.
Sherman, Matthew (2009). *A Short History of Financial Deregulation* in the United States.
*Center of Economic and Policy Research* (July 2009). Washington, D.C.

Smith, Adam (1776). *An Inquiry into the Nature and Causes of the Wealth of Nations*.
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United Nations, OECD, IMF, World Bank, European Commission (2009). *System of National Accounts 2008*. United Nations document symbol: ST/ESA/STAT/SER.F/2/REV.5. New-York: United Nations.
PART IV - REPRODUCTION AND THE RATE OF PROFIT

We already mentioned that the profit rate is a fundamental variable in neo-classical theory, where it is defined as equivalent to the marginal productivity of capital, itself considered as a factor of production. In this theory the interaction of supplies and demands under the supervision of an auctioneer is supposed to ensure the equalization of profit rates when equilibrium is reached. Neoclassical theory therefore deals with an average profit rate which prevails in the whole economic system. We showed that this is not theoretically justified, if only because capital is not a factor of production. It cannot create any surplus, but only plays the role of a catalyst in the production process, where it boosts labor productivity.

The profit rate is also a prominent variable, and is also an average at the same scale in Sraffa's theory of production prices, even though it must be exogenously given. However it is wrongly defined as a rate applying to intermediate goods, even before the problematic introduction of fixed capital in the theory. Although Sraffa's theory invalidates the idea that the rate of profit could be considered as the measure of the marginal productivity of capital, it is supposed to provide a distribution key for profits to share with labor the surplus created through the production process. We showed however that there is no such thing as a surplus, and that the introduction of fixed capital in this theory is theoretically unsound, which ultimately invalidates the theory of production prices, and means that commodities do not produce commodities.

Marx for his part correctly defines profit as the monetary realization of surplus-value, but he too considers that competition brings about an equalization of profit rates, leading to the existence of an average rate of profit for the whole economic system. Indeed he writes in Chapter 9 “Formation of a general rate of profit (average rate of profit) and transformation of the values of commodities into prices of production”, in volume 3 of Capital: “the rates of profit prevailing in the various branches of production are originally very different. These different rates of profit are equalized by competition to a single general rate of profit, which is the average of all these different rates of profit. The profit accruing in accordance with this general rate of profit to any capital of a given magnitude, whatever its organic composition, is called the average profit. The price of a commodity, which is equal to its cost-price plus the share of the annual average profit on the total capital invested (not merely consumed) in its production that falls to it in accordance with the conditions of turnover, is called its price of production” (Marx, 1894, p. 108). Moreover Marx establishes a law of the tendential fall of the profit rate which is supposed to provoke a crisis of the capitalist mode of production, a question which we shall also examine in this last part.

The reader might therefore consider it strange that, apart from the chapter on rent, we did not introduce so far in our models the average rate of profit as such, although they integrate fixed capital and profits. But our average rate of profit in the chapter on rent is not at all an average rate at the scale of the economic system: it is a statistical average rate prevailing in a branch producing only one commodity. In fact if we did not introduce a general average rate concerning the whole economic system until now, it is simply because there was no
theoretical need to do so: the average rate of profit is an endogenous variable, which cannot be determined as long as all values and prices have not been determined. In our theory the rate of profit is nothing else than a resultant, a mere statistical ratio between profits as a transferred money income deriving from the property of fixed capital and the corresponding amount of this fixed capital. And we showed that logical constraints governing the realization of the product are incompatible with the theoretical existence of a general profit rate, other than a mere statistical average. This corresponds truly to what can be observed in the real world.

From what was said above, and since it takes a great place in theoretical debates, it remains nevertheless that the question of nature and evolution of the rate(s) of profit certainly presents some theoretical interest and deserves to be dealt with, within the framework of our analysis, as well as the question of its potential influence on the occurrence of crises concerning the capitalist mode of production. This task will be carried out in the following chapters of this last part.
# Chapter 17. Profits, rate of profit and reproduction

This chapter is dedicated first to a more in-depth analysis of profits. It starts in a first section by exploring the complex nature of profit rates, which explains the practical difficulties to measure them in the real world, due in part to their multiplicity. This leads to propose then some alternative indicators, like the amounts of profits or the profit/wages ratios. A second section shows how the reproduction of the system is problematic, which explains the probability of crises coming from inherent difficulties of reproduction, and why Keynes viewed Say's law as essentially not true. A third section shows that there are some remedies to crises. One of them, autonomous investment, leads to the analysis of the Keynesian multiplier, and shows that the value of this multiplier cannot be higher than 1. A fourth and final section discusses briefly the link between crises and evolution of the profit rate, to conclude that is less than obvious, and that the Marxist law of the tendency of the rate of profit to fall needs also similarly to be reassessed.

## 1. The complex nature of profit rates

Apart from the fact already mentioned that there was no need to introduce the rate of profit in our theory so far, there are a few other reasons explaining why we did not do it. One of them is that we did not introduce the denominator of the expression giving the profit rate, i.e. the accumulated stock of fixed capital and its measurement, because a precondition for doing that is first of all to have a coherent theory of value and prices. Now that it is the case, we will address this question in the last part of this book, devoted to the evolution of the profit rate as related to the evolution of other variables. Another reason for not introducing the profit rate so far is obviously, as we just indicated at the end of last chapter, that there is a multiplicity of profit rates. Before addressing this aspect of the question, it is also worth to recall that even from an empirical point of view, there is a genuine difficulty just to measure actual or “real” profit rates.

### 1.1. The practical difficulties to measure profit rates in the real world

In fact, the difficulty of measuring profit rates in the real world stems from the problems that capitalist firms themselves have in practice in measuring the denominator of the expression giving the profit rate, i.e. the stock of capital, particularly in view of their conception of the nature and extent of this capital stock.

Within the framework developed by the International Integrated Reporting Council (IIRC), an international committee working on the issue of business accounting, a company's capital is made up of several asset classes: financial capital (securities) and capital equipment (buildings, factories, equipments); natural capital (natural resources, impact on the environment) and social capital (reputation, ability to deploy in a given context); and lastly, the "intangible" capital formed by the human capital (qualifications, training, organization, etc.) coupled with intellectual capital (knowledge, know-how, patents, ability to innovate).
The measurement of each of these components is difficult because it depends on norms, always subject to interpretation, and judgments which are necessarily subjective. Effective measurement of the capital stock in practice thus depends on multiple conventions. It is therefore extremely hazardous, and thus largely devoid of theoretical relevance. This explains that companies often entrust this task of measuring the value of their capital stock to consultants or chartered accountants. This difficulty can be clearly observed in corporate mergers, since the value of the acquired company is most often the result of a process of negotiation of this value that is not scientific in nature. So much so that in a number of cases the value finally retained turns out to appear a posteriori as erroneous.

It should be added that capitalist enterprises have a strong interest, for tax reasons, in minimizing the amount of their taxable profit, thereby reducing the posted profit rate. As for the tax rules themselves, which come into play when it comes to measuring after-tax profit, they are so complex, particularly in terms of depreciation, that large companies employ many tax professionals for the purpose of tax optimization, which often involves the relocation of profits to lodge them in tax havens, by playing on internal transfer prices between subsidiaries.

The result of all these difficulties and all these manipulations is that most capitalists firms themselves are probably not aware of their own rate of profit! Both the numerator and denominator of the fraction giving the rate of profit are thus in practice tainted with serious uncertainties which forbid to make the profit rate play the role which theoreticians, neoclassical like Marxist ones, would like to assign to it. The fact that the managers of firms do not know for sure the rate of profit does not in any way seem to bother them, since they prefer to concentrate on the rate of return on equity (ROE) which is another concept: in corporate finance, it is a measure of the profitability of a business in relation to the book value of shareholder equity, also known as net assets, or assets minus liabilities.

In any case the real world shows that there is a multiplicity of profit rates, a phenomenon also deriving from strong theoretical reasons, which will now be examined.

## 1.2. The multiplicity of profit rates

### 1.2.1. Some technical or "macroeconomic" reasons

The models used so far were based initially on the assumption of the homogeneity of the margin rates (considering for instance that we had $1-u=a$). But in the real world there is no reason why the margin rates should be the same for all sectors and all firms. It was especially the case in the first and simplified model, where they corresponded to the share of available fixed capital obtained at each stage of the production process. In general, as we had indicated when studying this model, there can be as many distinct values for the $u$ coefficient, and therefore for the margin rate $1-u$, as there are sectors or firms.

Admittedly, at each stage of fixed capital purchases within section I there can be a distinct rate of profit, but its formulation is very simple, since in the simple model all profits are invested. Consequently, the amount of fixed capital is nothing more than the sum of profits,
identical from period to period, accumulated in the form of investments in fixed capital, as long as this capital is used in the production process. Therefore, assuming that the lifespan of fixed capital corresponds to t times the production period, the relation between the amount of profits at each stage and the corresponding fixed capital is expressed in the form:

$$r_{It}(price) = \frac{a(1-u_i)^i L_i}{a(1-u_i)^i t_i L_i} = \frac{1}{t_i}$$

The formula is effectively simplified to the point that the profit rate appears to be the inverse of the average fixed capital lifespan, the same fixed capital being employed at each particular stage of fixed capital purchases within section I. But there is absolutely no reason for the actual lifespan of fixed capital to be the same at each of these stages. Even if these lifespans are not necessarily very different, profit rates are nonetheless formally different: the longer the service life, the lower the rate of profit, which is logical since the amount of profit needed at every period to renew the fixed capital that has reached the end of its productive life is itself all the more limited as its life-time is long.

### 1.2.2. Some “microeconomic” reasons

As soon as we introduced capitalist consumption in our second model, it became obvious that prices and therefore profit rates do not have only a macro-economic dimension, and that they also have a micro-economic component, because the realization of profit appears then as a way, not only to reproduce the stock of fixed capital, as in the simple model, but also for the owners of this capital to get a share of capitalist consumption which they would like to be as large as possible. This introduces a powerful incentive for capitalists to increase their prices as much as market conditions allow them to do. There is no question of denying that this makes them dependent on these market conditions and thus partly, among others, to the law of supply and demand. For neo-classical economists, competition is in this context supposed to push for the equalization of profit rates. But neo-classical theory has never produced a rigorous and convincing demonstration of how competition leads to such an outcome.

Of course, capital is supposed to flow off from sectors where demand is low, and the rate of profit supposed to be equally low as a result, in order to flow into sectors where demand is high and the rate of profit supposed to be high: these moves are supposed to bring about an equalization of profit rates. But it is the starting point of this reasoning, according to which a low rate of profit necessarily coincides with a weak demand, which is not demonstrated but postulated. Whereas in the real world the rate of profit can be low or high for other reasons than the weakness or strength of demand, including macroeconomic reasons such as those developed so far.

Conversely, we can see that the whole strategy of capitalist enterprises consists precisely in limiting competition in order to obtain as much market power as possible, going as far as practicable to obtain some kind of monopoly power, which can be achieved among others by taking advantage of market imperfections, such as asymmetric information. The natural
objective of any firm is to achieve the power to decide freely of its own prices in order to
maximize its corresponding margin rate. And there is no reason for this market power to be
the same for all sectors or all goods.

Markets are also marked by the existence of multiple externalities, which do not allow prices
to play the role assigned to them by neo-classical theory, a role supposed among other things
to lead to the equalization of profit rates. Such a functioning of real markets then pushes not
to an equalization but rather to a differentiation of profit rates. It is therefore clear that in the
capitalist mode of production the preponderant situation corresponds to a multiplicity of profit
rates. This is a good reason, and in itself a sufficient one, to desacralize the concept of average
rate of profit and reduce its importance as regards its role of a performance indicator supposed
to guide business investment.

If such a multiplicity of profit rates seems for all these reasons inevitable in a state of simple
reproduction, it is also a consequence of the dynamics of the system, because as soon as we
abandon the assumption of simple reproduction there is no reason for each sector to grow at
the same rate as the others. In fact the demand for each particular good, which depends on
many factors, usually grows at its own rate, which implies that growth is never a homothetic
process, a question on which we will elaborate a little.

1.2.3. Growth is not a homothetic process

If we leave for a moment the theoretical world of simple reproduction to go to that which
Marx called enlarged reproduction, corresponding to a situation of growth of the economic
system, it is a fact of experience that growth is never a transformation without a deformation
of a number of economic parameters.

The economist who best described and theorized the dynamics of the capitalist system is
certainly Joseph Schumpeter, in his well-known book, “Capitalism, Socialism and
Democracy”, originally published in 1942, where he coined the expression of “creative
destruction” to characterize the usual growth process of the capitalist mode of production. The
whole sentence where this expression appears deserves to be quoted: “The opening up of new
markets, foreign or domestic, and the organizational development from the craft shop and
factory to such concerns as US Steel illustrate the process of industrial mutation that
incessantly revolutionizes the economic structure from within, incessantly destroying the old
one, incessantly creating a new one ... [The process] must be seen in its role in the perennial
gale of creative destruction; it cannot be understood on the hypothesis that there is a perennial
lull” (Schumpeter, 1976, p. 83).

Schumpeter continues: “The first thing to go is the traditional conception of the modus
operandi of competition. Economists are at long last emerging from the stage in which price
competition was all they saw. As soon as quality competition and sales effort are admitted
into the sacred precincts of theory, the price variable is ousted from its dominant position.
However, it is still competition within a rigid pattern of invariant conditions, methods of
production and forms of industrial organization in particular, that practically monopolizes
attention. But in capitalist reality as distinguished from its textbook picture, it is not that kind
of competition which counts but the competition from the new commodity, the new
technology, the new source of supply, the new type of organization (the largest-scale unit of
control for instance) - competition which commands a decisive cost or quality advantage and
which strikes not at the margins of the profits and the outputs of the existing firms but at their
foundations and their very lives" (Schumpeter, 1976, p. 84).

We could not say better, which explains the length of the quote, but such a situation as
described by Schumpeter implies that at any point in time there are a number of firms which
go bankrupt or at least stop their activity and conversely a number of new firms who start
their operations. This necessarily means that at any time there is a wide spectrum of profit
rates, from the negative rates of firms which are expelled from their market and closing, or
have just been created and are struggling for growth, to the highly positive ones of successful
start-ups.

More simply, and even without creative destruction, the fact that each particular sector has its
own rate of growth implies that the need for new investments differs from one sector to the
other, and that ceteris paribus less profits need to be invested in sectors with a low growth rate
than in sectors with a high growth rate. Although there is no direct correspondence between
this observation and the rate of profit, this also goes in the direction of the differentiation of
profits rates.

1.2.4. The differentiation of profit rates is inevitable

From the foregoing we can understand first of all the "technical" dimension of profits and the
rate of profit. Indeed their amount or magnitude have to be such as making it possible to
recover the fixed capital indispensable for the reproduction of the system, and this in section I
as well as in section II. Thus when the rates of growth are heterogeneous from one commodity
to the other, the technical components, i.e. the amounts of profits needed for the sole
reproduction of the system, become similarly heterogeneous.

But we can also understand the dual nature of profits, because beyond this technical
dimension, and as the monetary expression of surplus-value, profits are also the source of
capitalist consumption. This gives to profits and the rate of profit a social dimension which, as
we pointed out, is expressed differently in each of the two sections of production. We
therefore understand why there is no reason a priori for the rates of profit to be identical in
both sections. Within each section, the same social dimension plays its role for each particular
commodity, meaning that in each section there is no reason for profit rates to be identical in
the production of different commodities. Moreover there is neither a particular reason nor a
particular mechanism in the economic system to ensure that both dimensions, i.e. the
"technical" one and the social one, should necessarily be related.

In other words, the price system which theoretically allows the system to adjust and reproduce
itself harmoniously has no reason to be necessarily the price system which derives from
conflicts for the actual sharing of surplus-value. This last price system itself has no reason
either to be the price system ensuring the equalization of profit rates between the two sections
of production, or within each section between the firms belonging to it. From this point of
view competition between capitalists, supposed to ensure the equalization of these rates in
neo-classical theory, in so far as it is a competition for the distribution of a prefixed and non-
extensible amount, actually plays a reverse role of additional differentiation, aimed at
ensuring not only the replacement of fixed capital, but also the maximum level of
consumption made possible by the balance of power prevailing in each particular supply
chain. The ultimate objective of capitalists as individuals is indeed their level of consumption,
the ownership of fixed capital being only a necessary mediation to achieve it.

Finally, competition itself is a driving force which does not play its role only through the price
system, but also through innovation and a permanent change of structures and organizations,
which ends up by a continuous reshuffling of market shares and profit rates. The globalization
process, through its relocations, is also conducive to a wide range of profit rates.

Let us conclude on this point that if capitalists really wanted to achieve an average rate of
profit, they would need to know at the outset the value of this average rate, or at least have
some approximate idea of its value, which is quite impossible for all the reasons which have
been exposed. Therefore when making strategic decisions regarding for instance the nature
and magnitude of their investments they have to rely on other indicators.

Before touching upon this question, it may be useful to recall that neo-classical theory itself
has come to deal with the multiplicity of profit rates.

1.2.5. Neo-classical theory and the multiplicity of profit rates

Having reached this stage, it is interesting to note that within the framework of the theory of
general intertemporal equilibrium, which constitutes to some extent the culmination of the
neo-classical theory, one of the few authors to have published on the subject, Edmond
Malinvaud, also comes to the conclusion that there is a multiplicity of “rates of profit”, in his
“Lectures on Microeconomic Theory” (Malinvaud, 1975, for the third French edition).

We will not develop here a full and detailed criticism of this theory<fnref n="13" />. Suffice it to say that
these rates are defined in fact as commodity own-rates of interest. On this background, in
order to introduce fixed capital considered as a factor of production, Malinvaud introduces the
concept of equilibrium rate of interest, such that “for every commodity and every period, the
market own-rate of interest is equal to the subjective own-rate of interest of every consumer
and to the technical own-rate of interest of every enterprise”. But, as he has the honesty to
recognize it himself in the third edition of his “Lectures”: “In general the own-rates of interest
corresponding to one period and to different commodities do not coincide. For them to
coincide, discounted prices should be such that ratios $\frac{P_{q,t+1}}{P_{qt}}$ take the same value for all

<footnote n="13">¹³ A detailed criticism can be found in my PhD thesis: Flamant, C. (1977). "Hypothèses et concepts dans les théories du capital, de la valeur et de la répartition » . University of Paris I - Pantheon-Sorbonne. pp. 138-157.</footnote>
commodities. But such an eventuality does not have a priori any reason to occur” (Malinvaud,
1975, p. 244).

The theory of intertemporal equilibrium in practice remains unable to introduce on the basis
of its own assumptions the concept of an equilibrium rate of interest. The notion of interest
rate, introduced on a purely definitional basis, cannot in any case be linked to the marginal
productivity of a “factor of production”, i.e. fixed capital. Neo-classical theory, in spite of the
diversity of its attempts and refinements, is unable to define fixed capital as a set of produced
means of production and at the same time as a factor of production having at equilibrium a
uniform remuneration: the profit rate (or the interest rate in this case). When it succeeds in
defining fixed capital as a factor of production, it is only by suppressing the first term of its
definition, by means of adopting the assumption of an economic world containing in fact only
one commodity, which negates all its problematic of value.

**1.3. Alternative indicators: the amount of profits and the profit/wage ratio**

It follows from the above discussion that for capitalists the rate of profit is not a relevant
indicator for the management of their enterprises. It is so because neither in theory, which
highlights the multiplicity of profit rates, nor in practice, the profit rate cannot be a good
indicator for the day to day management of a capitalist enterprise, owing to the difficulty to
measure it, i.e. to know precisely its magnitude, and even less where a firm’s particular profit
rate might stand among a cloud of individual profit rates, mostly unknown. Moreover, as an
average between a wide range of individual rates, it cannot be a good instrument to analyze in
a simple way the functioning of the capitalist system.

In fact, the profit rate is practically not used as an indicator, either by capitalists themselves,
for example to guide their investment decisions, or by investors in the stock market, who
prefer to use the ratio of net profit per share to guide their speculative activity, or even by
national accountants to measure the performance of firms. Nobody seems to refer to the
existing overall rate of profit to assess the overall performance of a national economy. The
search for the maximum profit rate is therefore not the central engine behind the operation of
the capitalist system.

But this should not imply that the search for the maximum amount of profit is no longer a
determining criterion of the functioning of capitalist enterprises. It is indeed a quantity which,
not being a ratio between two distinct variables, is much easier to apprehend. Thereby, if
capitalists have nevertheless a maximization objective regarding their profits, which is
generally the case, this objective indeed remains the actual amount of monetary profits.

This is clearly seen in current practice with the importance given by business accounting to
EBITDA (earnings before interest, taxes, depreciation and amortization), which corresponds
at macroeconomic level of national accounts to what is called gross operating surplus. It is
therefore safe to assume that the true motive behind the behavior of capitalist firms is the
maximization of the amount – and not the rate - of profit.
This search for maximum profit takes place in an ideological framework delimited by neo-classical theory, in which this profit is supposed to correspond only to the marginal productivity of capital. From a microeconomic point of view, for a given price level and revenue provided by a given commodity produced by an enterprise, the amount of profits is established as a difference between value added and the amount of wages. The amount of profits is thus perceived rightly, at least at this level, as a competitor to the amount of wages in the sharing of this value added. It follows that the search for maximum profit leads to the search for a reduction in labor costs, both at the level of firms and at global level. With the rise of neo-liberalism, this decrease is supposed to be achieved among others by a removal of rigidities supposed to plague the labor market.

Let us therefore conclude that, in the real economy and the world as it is, what capitalists are looking for is first and foremost a rise in the profit/wage ratio. As we have seen, moreover, that profit is nothing else than monetized and redistributed surplus-value, even to the point that in section II producing consumption goods this profit/wages ratio is precisely equal to the rate of surplus-value (i.e. $k_c$, or $\frac{k+c}{1-c}$). We thus come back to what constitutes the true and actual engine of the capitalist mode of production: the search for the highest possible rate of surplus-value. But as we will now show, the operation of such an engine can have adverse effects for the desired goal, inducing a structural instability of the system.

All these findings allow us to formulate a new principle:

**Principle 36:** The average rate of profit cannot be considered as a meaningful element of economic theory. Indeed, apart from the difficulty to simply measure it in the real world, it is nothing else than a mere statistical average. The real world, as well as a number of theoretical factors deriving from the nature of profit formation and realization, show that there is a multiplicity of profit rates both in theory and practice, and that the nature of economic activity, based on competition among firms, always pushes to a differentiation of these profit rates. The profit/wage ratio plays a more important role for the understanding of economic processes.

## 2. Reproduction of the system is problematic

### 2.1. Reproduction is possible, but not probable

The analysis performed in both the simple model and the model with capitalist consumption lead us to observe that there is a set of magnitudes for the various variables which allows for the full realization of the product, in the sense that all of the produced commodities are sold and all of the incomes are realized and spent.

This makes us consider that both models are “almost” in the universe of Say’s law, according to which all commodities which are produced can be sold, because they can be bought by all the incomes created on the occasion of production. This is the meaning generally accepted for this quote from chapter XV “Of the Demand and Market for products” of his “Treatise on
Political Economy”, originally published in 1803: “It is worthwhile to remark, that a product is no sooner created, than it, from that instant, affords a market for other products to the full extent of its own value. When the producer has put the finishing hand to his product, he is most anxious to sell it immediately, lest its value should diminish in his hands. Nor is he less anxious to dispose of the money he may get for it; for the value of money is also perishable. But the only way of getting rid of money is in the purchase of some product or other. Thus, the mere circumstance of the creation of one product immediately opens a vent for other products” (Say, last English edition in 2001, p. 57).

However we have demonstrated in this book and from our models that not all incomes, but
only wages (or more generally the remuneration of labor) are created on the occasion of
production, since incomes deriving from property are created in the sphere of circulation, as
transfer incomes realized through exchanges of commodities against money. This is the
reason why we wrote “almost” in the last paragraph. But the outcome is nevertheless the
same, since - as we showed, these incomes are indeed clearly sufficient to buy the whole
product.

Say argued that because production necessarily creates demand, a "general glut" of unsold goods of all kinds was impossible. But he considered nonetheless that if there were an excess supply of one good, there should be a shortage of others: "the glut of a particular commodity arises from its having outrun the total demand for it in one or two ways; either because it has been produced in excessive abundance, or because the production of other commodities has fallen short" (Say, 2001, p. 57). It is clear from this quote that Say at least accepted the possibility of disadjustments between supply and demand on individual markets.

Coming back to our models, the introduction of capitalist consumption did not call into
question the theoretical possibility of a complete realization of the product, nor consequently
of a harmonious reproduction of the system. But this could only take place because on paper,
i.e. in the world of theory, all of the different parameters involved in this reproduction, and in
particular prices, adjusted to levels that effectively allowed this harmonious reproduction.
However, in practice and in the real world, there is no reason to believe that these parameters
will be precisely set at such levels for three reasons.

First of all, and this is the first one, there is no reason to think that monetary prices, as they are
set independently by each capitalist enterprise, will allow for each commodity, be it a
consumption good or a fixed capital good, to sell all the quantities produced, and thus to
achieve exactly the expected profits, on the basis of which production was launched. This
would imply that each entrepreneur, even before equilibrium is reached, would have a perfect
information on all the prices and quantities which can be known only at this point. Therefore
if prices are not equilibrium ones – and nothing can guarantee that they are such in a world of
imperfect information, there will be excess supply on some markets, and at the same time
excess demand on others. Assuming now that prices are more "viscous" than quantities
produced, this can only result in an adjustment first by quantities. This hypothesis is not
devoid of any empirical basis, because in the real world it is easier to change the daily
production of a production unit (workshop or plant), something which can be done almost immediately, than to change a price catalog, which cannot be done every day.

On the other hand, and this is a second reason for maladjustments, once profits have been realized, and even assuming that they were realized in accordance with the original expectations, there is nothing to suggest that they will be spent autonomously by each capitalist in a way that achieves exactly the closure of the circuit and the reproduction of the system, whether for the purchase of consumer goods or for investment in fixed capital.

This comes from the fact that investment is a bet on the future, that the future is uncertain, and that this uncertainty is not probabilizable. Here one cannot but mention once more Keynes, who in chapter XII of the General Theory on "The state of long-term expectations", develops the idea that investment, insofar as it results from individual decisions of entrepreneurs, is influenced by their "animal spirits": "Most, probably, of our decisions to do something positive, the full consequences of which will be drawn out over many days to come, can only be taken as a result of animal spirits - of a spontaneous urge to action rather than inaction, and not as the outcome of a weighted average of quantitative benefits multiplied by quantitative probabilities" (Keynes, 1936, chapter 12, p. 103).

It is no wonder therefore that Keynes viewed Say's law as essentially not true, and considered that effective demand, in the meaning of expected demand, rather than supply, is the key variable that determines the overall level of economic activity. Consequently there is no reason to expect enough aggregate demand to produce full employment.

Moreover, there is a third reason for maladjustments: while the dominant economic theory considers capital as a factor of production which - again when equilibrium is reached, must ensure a rate of profit identical to all its owners, the beginning of the present chapter has demonstrated on the contrary that the reproduction of the system implies a differentiation of these rates of profit, which is incompatible with this neo-classical representation of reality. But this differentiation of profit rates is a factor of increased rivalry between capitalists, by logically pushing those who realize profit rates deemed lower than those of their competitors to do everything possible to increase the profits levied on their own workers. As will be seen below, this creates a constant downward pressure on wages and upward pressure on profit shares and thus profit rates, which pushes primarily to a rise in the rate of surplus-value. Such a rise results from an action aiming at bringing down the level of wages, since this is indeed the most immediately accessible parameter. It is this same pressure that is at the origin either of productivity investments in the country where capitalist firms are located, or of investments abroad, in the form of relocations, which have exploded in advanced economies over the last 40 years, with the development of globalization.

To overcome these causes for maladjustment, capitalism has an absolute need for coordination between agents, in the form of a collective regulation, and it makes sense that this regulation should be the task of the State, as representative of the community and general interest. Indeed there has been in the last century an important regulation by the States, which prevailed in the aftermath of the second world war and continued for a good thirty years in most developed capitalist countries, up to the end of the seventies. This is certainly, together
with the needs linked to Europe's reconstruction, the main reason for the high rates of economic growth and low levels of unemployment registered in the main occidental capitalist economies up to the beginning of the eighties.

However, a neo-liberal ideology based on questioning the role of the State in all areas has developed in the opposite direction from the beginning of the 1980s. This ideology flourished in the name of an individualism proclaiming the benefits of individual freedom in all areas, and conversely the harmfulness of the State and its regulation role. The progressive implementation of this ideology's recommendations all along the following decades has resulted in the constitution of what could be called a neo-liberal mode of regulation of capitalism, if this expression was not a magnificent oxymoron, because the objective of the neo-liberals is on the contrary the most extensive deregulation of the economy. The resulting long term crisis, which began early in the 1980s, has been marked by a generalized decline of growth rates and real wages in practically all of capitalist economies which adopted this ideology. It is a sign of the failure of this ideology and of the absence or failure of economic policies that should have ensured a smooth functioning of the capitalist mode of production, at the national level as well as internationally.

These last developments provide us with the logical bases to express a new principle:

**Principle 37:** It might exist a set of variables which make it theoretically possible to guarantee a balanced reproduction of a capitalist economy, in the neo-classical sense of ensuring a simultaneous equilibrium on all markets. However such a reproduction is practically impossible to obtain, for a number of equally theoretical reasons. First, because of the decentralized nature of such an economic system, which implies that decisions by capitalists, who fix prices and make investment decisions, are made independently, moreover in situations of imperfect information, and not coordinated. Second, because these decisions are made within time frames and based on expectations about the future which cannot be rational, because of the natural uncertainty which characterizes what happens in the future. Third because the dynamics of the system, if they are left unregulated by State authorities, go in the direction of a permanent increase in the rate of surplus-value, which in itself has destabilizing effects.

## 2.2. Crisis as coming from inherent difficulties of reproduction

It can be shown that it is the constant search for the maximization of profits, although it is the engine of the capitalist mode of production, which is also at the same time its worst enemy. And this because of its harmful consequences on the reproduction of the system, which are at the roots of its crises. This will be shown first by using essentially the simple model, since it is good enough for such a demonstration, without unduly complicating it.

### 2.2.1. Reproduction in section II

Let us suppose that after a production cycle which has been carried out without any difficulty, capitalists of section II, for whatever reason (for example, the perception that the amount of
their profits is insufficient), want to increase these profits during the next cycle. For any
capitalist who has a microeconomic perception of his business, the easiest way to do this is to
reduce the amount of wages. This can be achieved either by reducing the amount of money
wages paid to workers, something which can be hard to obtain, or by reducing the number of
workers, which is generally simpler to achieve, while betting that increased productivity of
remaining workers will maintain physical output at its previous level.

In the context of the simplified model, this results in a reduction in $L_{II}$, which falls from $L_{II}$ to $L'_{II}$, with $L'_{II} < L_{II}$, and hence in $W_{II}$, which decreases to $W'_{II}$ (with an unchanged money wage). If the price of the product of section II, i.e. the supply of consumer goods, is kept unchanged at $L_I + L_{II} = W_I + W_{II}$ (with $\bar{w}=1$), ipso facto the demand for these goods emanating from workers will be reduced to the equivalent of $L_I + L'_{II} < L_I + L_{II}$. The value of the product of section II will also go down from $L_{II}$ to $L'_{II}$, and the price of the sold product will therefore be lowered to $L_I + L'_{II}$. Depending on whether the rise in labor productivity has offset or not the decline in the number of workers employed, we will be in a situation either of a maintained level of the quantities which are produced, or a fall in these quantities (a recession). The realized profit will not have increased, although its rise was the initial objective, but it will nonetheless remain fixed to the same amount $L_I$. The profit/wage ratio in section II, which in this section is, as we know, identical to the rate of surplus-value, i.e. $\frac{L_I}{L_{II}} = k$, will have increased, becoming $\frac{L_I}{L'_{II}} = k'$, with $k' > k$. But the number of workers employed will have stayed at its reduced level $L'_{II}$: unemployment will have increased.

2.2.2. Reproduction in section I

It has just been observed that, as a result of a fall in the cost of labor initiated by capitalists of section II, they record a fall in the overall amount of their sales and the failure of their attempt to increase the amount of their profits, which stays at $L_I$.

Let us suppose also that, since they maintained the amount of their profits at their previous
level, and in order to ensure the growth of the physical productivity of labor in section II,
capitalists in this section wish nevertheless to maintain the level of their investments, by
continuing to buy fixed capital from section I for a price $L_I$, equivalent to the amount of their
profits. If this is the case, then there is no reason at first sight that the initial decision of
capitalists in section II has repercussions on the sales, employment and profits of section I.
But can it be so?

To answer this question, let us recall that this analysis is based on a more general assumption
of the uniqueness of the rate of surplus-value, considered as the result of a global social
phenomenon, a rate which is the same for all workers, whatever the section in which they
work. As unemployment has increased as a result of decisions taken in section II, the
bargaining power of all workers has inevitably decreased, which points to a subsequent fall in
wages, first in section II, but also in section I. It is indeed recalled that the objective pursued by section I capitalists, like those in section II, is indeed to increase the amount of their profits, which at the micro-economic level of each enterprise inevitably means to lower the amount of wages, which is made easier by the rise in unemployment.

If this reduction in wages materializes, then the nominal wage level in section I will drop from $L_I$ to $L_I'$. Paradoxically, this will result in a relative drop in the rate of surplus value, compared to the rate $\frac{L_I}{L_I'} = k'$, since a fall in the amount of wages in section I will have repercussions on the sales of consumer goods in section II, which will not reach a level $L_I + L_I'$, but rather a level $L_I' + L_I' < L_I + L_I'$. For this same reason, capitalists of section II will see their profits go down from $L_I$ to $L_I'$ (with $L_I' < L_I$), and therefore will not be able to maintain their purchases of fixed capital at its previous $L_I$ level. They will have to reduce their investment to an $L_I'$ level, which will reduce the amount of sales and profits of section I by the same amount. With a coefficient $a$ unchanged, the profit of section I actually becomes $L_I' \frac{a}{1-a} < L_I \frac{a}{1-a}$. This can only result in a fall in output and employment in section I, coming after the fall recorded in section II, ceteris paribus (the question of rising labor productivity is here left out).

To avoid burdening the demonstration, we will not discuss in detail what would happen if the initial decline in sales of consumption goods in section II, due to the fall in wages in this section, translated into a direct and proportional decline in section II purchases of fixed capital from section I, but it is not difficult to imagine that the effect on sales and therefore on output and employment in section I would be just as negative as in the case that has just been developed.

The new rate of surplus-value would then become $k'' = \frac{L_I'}{L_I''}$ a rate which might possibly be lower than the initial rate of surplus-value. The question of how this evolution can be reflected in the evolution of the average rate of profit will be examined in the following chapters, which deal precisely with the evolution of this last rate.

It can be concluded nevertheless that if the capitalist mode of production is characterized not only by an inherent antagonism between workers and capitalists, but also by competition among capitalists themselves, the latter pushes each one of them to realize the maximum amount of profits, and therefore the maximum amount of surplus-value, since profits are only surplus-value realized and redistributed among the capitalists under a monetary form.

And it has just been shown, albeit in a simplified framework, that the simultaneous pursuit of maximum profit by all capitalists, through the fall in the amount of wages which is its logical corollary at micro-economic level, leads at macroeconomic level to the reverse of the desired objective, and brings the system into a deflationary spiral of declining values, employment,
and ultimately profits. These findings highlighted by the above demonstration allow us to
formulate a new principle:

**Principle 38:** It is the very engine of the capitalist system, i.e. the pursuit of maximum profit at micro-economic level, which at macro-economic level constitutes a powerful factor of structural instability. Starting with a reduction in wages, it leads to cascading maladjustments that do not allow a full realization of the product and therefore hamper the reproduction of the system.

To be sure, the capitalist mode of production has not been functioning well over the last 40 years, at least in the most advanced economies, corresponding roughly to the OECD member countries. However, apart from the world financial crisis of 2008, followed by a deep recession in almost all of these countries, there has not been simultaneous true or prolonged recessions in these countries during this period, but rather a general reduction in the rate of GDP growth, accompanied by a significant decrease in the rate of productivity growth, a stagnation of real wages and a rise in income and wealth inequalities. This evolution might be the sign that the deflationary spiral evoked in the last paragraph has been counterbalanced by some kind of remedies against the fall of the system into an outright crisis. We will try to identify them in the next section.

**3. Some remedies against crises**

Quite paradoxically, capitalist consumption can be a remedy to such a crisis situation as
described in the last section, together with another remedy which is autonomous investment.

**3.1. Capitalist consumption as a remedy for crises**

To understand how profits can be at the same time a scourge and a solution to the difficulties of reproduction which we just pointed out, we have to refer again to this fundamental mechanism highlighted by Keynes, who might not have realized its full scope: the widow's cruse.

To show that, we have obviously to get capitalist consumption back into the picture, which precisely corresponds to our second model with capitalist consumption. Then we can go back to subsection 2.2.1. above, where the insufficient demand in section II was due to a reduction in the amount of wages paid in this section. Supposing now that this fall in wages comes from a reduction, not in the number of workers, but in the level of nominal wages, then the value of commodities produced in section II in terms of average social labor is unchanged, as well as their price, even though their money value has decreased, from $W_{II}$ to $W'_{II}$, with $W'_{II} < W_{II}$.

But let us now consider that capitalists from section II can borrow an amount $W_{II} - W'_{II}$, corresponding to the reduction in demand for consumption goods from their own workers. Then, if they spend this borrowed money to buy the consumption goods left available for sale in section II (because they were not sold to workers due to the fall in their purchasing power), we are back to the mechanism of the widow's cruse highlighted in chapter 12. Capitalists of
section II are able to buy all the consumption goods left over, and for which all wages amounting to $W'_{II}$ have already been paid, which means that the purchase of these goods will generate pure profits and allow to sell all of the commodities produced in section II.

This will however take place at a price which is globally unchanged but cannot correspond to the same rate of surplus-value. Indeed, instead of being $P_{II} = W_{II}(1+k_c) = W_{II}\left(1+\frac{k+c}{1-c}\right)$ this price is now $P_{II} = W'_{II}(1+k'_c) = W'_{II}\left(1+\frac{k+c'}{1-c'}\right)$.

In other words the rate of surplus-value has increased, from $k_c$ to $k'_c$, because of the increase in capitalist consumption (limited to capitalists of section II where wages have been cut) from a $c$ share to a $c'$ share of the value of consumption goods, with $c' > c$.

However, for this to happen, several conditions have to be met:

- First, for each capitalist of section II the borrowed amount must be related to his share in the market for consumption goods, since it must correspond to the amount of additional profits which he will get by selling his whole production;

- Preferences of capitalists must be the same as those of workers if they had kept their purchasing power, precisely for the same reason.

If these conditions are fulfilled, then the consumption goods market will be cleared, capitalists of section II will have realized and spent a higher amount of profits, and they will be able to repay all the borrowed money to the banks. In other words money creation can be used by capitalists, not only for the payment of wages, but also to increase their consumption and their amount and share of profits.

This leads to the important conclusion that there are theoretically no limits to the amount of surplus-value and profits which can be obtained by capitalists, by having recourse to money creation, as long as they are able to repay the corresponding additional borrowings through increased profits. For a given quantity of fixed capital and investment, the increase in consumption is matched by additional profits: all that capitalists need to do after lowering the nominal wage rate and/or increasing the price of consumption goods is to absorb the consumption goods which workers are made unable to buy. In other words additional capitalist consumption substitutes to the missing workers' consumption.

Initially, the corresponding additional profits go to capitalist of section II, but undoubtedly those of section I will be able also to get an increased share of consumption goods, simply by increasing the price at which they sell fixed capital to capitalists of section II: they will thus increase their share of capitalist consumption. Once more we can see how prices play their distribution role, by distributing consumption goods between capitalists and workers and among capitalists themselves.
All this is nevertheless theoretical, because it implies that all of these additional profits must be spent on consumption goods, whereas in the real world it is obvious that the mechanism which we just described cannot work as smoothly and must necessarily face some implementation problems.

First because workers, especially in democratic countries where trade unions are strong, can oppose the reduction in their wages, be they nominal or real. This resistance explains that capitalists seek to relocate their activities from rich countries with high wages to poorer countries where wages are much lower. This process, known as globalization, has been and still is a powerful tool to overcome the resistance opposed by workers. The progressive reduction in the share of wages in the national income of all developed countries since the beginning of the eighties indeed testifies that this instrument has succeeded, and has correspondingly raised the share of profits in global income. This is the mechanism behind the rise of income inequalities in all of these countries. Over the years it is no surprise that these inequalities of incomes have translated to even higher inequalities of wealth. And since to benefit from lower wages implies for capitalists to invest in low-wage countries, the transfers of fixed capital involved have lowered the rate of growth in advanced economies and lead to their de-industrialization.

A second cause for difficulties comes from the fact that capitalists do not have the same structure of consumption as that of workers taken collectively: the richer they are and the higher is the share of luxury goods in capitalist consumption. As they grow richer, this implies therefore a reorientation of the productive system towards the production of luxury goods, which can take some time to materialize. Indeed all the available figures about the structure of consumption show that the luxury goods industry has grown faster after the world financial crisis of 2008 than the mass consumption industry.

But there is also a limit on the quantity of luxury goods which can be appropriated by an individual or his family: once somebody owns two or three luxury houses he usually does not need more, and the same can be said as far as beautiful yachts, private jets or luxury cars are concerned. As an exception is the case of ultra-rich people who become collectors, owning for instance dozens of houses in which they never live or dozens of luxury cars which they never drive.

This relative saturation of the luxury goods market means that with the rise in income and wealth inequalities a higher and higher share of profits no longer needs to be spent on commodities. Therefore an ever greater share of profits is diverted from the purchase of newly produced commodities to the purchase of assets such as works of art, ancient jewels, master paintings of past centuries, existing houses or palaces, or unproduced goods such as lands or even tropical islands. All of these are material assets, and one important category of assets is that of existing stocks, made of shares which represent the fractional ownership of corporations. These shares are ultimately equivalent to a property on a company's net assets. They can easily be bought from anywhere in the world once they are listed on one of the world stock markets. The growth of inequalities induced by the rising share of profits causes more investments to be made on stock markets, which pushes these markets upwards.
On top of that and over the last years a new practice has developed, with the same results, i.e. a rise in stock markets indices: this is the increasing recourse of large capitalists companies to the method of buying back their own shares from the market place. There are several reasons for that. First of all, when a company purchases its own shares, since firms cannot be their own *shareholder*, repurchased shares are absorbed by them: shares are most often cancelled, which reduces the number of shares outstanding. Secondly, a buyback also helps to improve a firm *price-earnings ratio* (P/E), because when this happens, the relative ownership stake of each investor in a company increases due to the reduction in outstanding shares. There are fewer shares, or claims, on the earnings of the company: net earnings per share (EPS) increase, which mechanically makes share prices to increase. Moreover, buybacks are paid out from cash, which is an asset, and this *reduces the assets value on the balance sheet*. As a result, *return on assets* (ROA) actually increases. *Return on equity (ROE)* also increases because there is less outstanding *equity*. In general, the market views higher ROA and ROE as positives. All this explains that buybacks are generally considered as increasing *shareholder value*.

This is certainly true at microeconomic level for a particular firm. At macroeconomic level, buybacks are just a transfer of profits from firms to individual capitalists who sell their shares, so that the global effect on incomes is neutral. However, by reducing the outstanding amount of shares, it corresponds to an equivalent reduction in global net wealth (at least if the reduction in the quantity of shares is not fully compensated by an increase in their price).

As far as the dynamics of an economy are concerned, there is however one problem with this reorientation of profits towards the acquisition of all sorts of assets. Indeed the price of all these assets is soaring, but profits employed this way are not creating any additional output since they are not spent on the market for newly produced commodities and in particular are not invested in new fixed capital, which should be the normal use of profits that are not distributed as dividends to shareholders. This is anyway the condition of future growth. This would not be a big cause for concern if the amounts involved were not huge. However they are enormous. For instance, in the US and for companies belonging to Standard & Poor's 500 alone, the amount of buybacks was 572 billion USD in 2015 and 536 billion USD in 2016, i.e. 3.2 and 2.9 % of GDP, respectively, in each of these years. This is to be compared with the fact that insufficient investment as a proportion of GDP might well be an explanation for the poor growth in productivity in the US economy over the last decades.

Moreover spending profits on assets rather than on real goods only corresponds to a reshuffling in the property of pre-existing assets. Bearing in mind that speculation is the purchase of an asset on a market with the hope that it will become more valuable at a future date, this practice fuels speculation on the assets markets, thus creating the risk of igniting a new financial crisis. All the more so that the last 20 years have seen the development of new and “virtual” assets, such as derivatives, which are highly speculative and potentially more dangerous than real estate or even normal stocks. Subprimes could be considered as such a derivative, linked to subprime loan mortgages. The last world financial crisis of 2008 showed that Minsky, whom we already cited in the introduction of this book, was certainly right when
in 1992 he explained in a short article (“the financial instability hypothesis”, op. cit.) how speculation was at the root of the financial instability of capitalism, a reason why the last crisis has sometimes been called a “Minsky moment”. But he considered that speculation was fueled by the building up of huge amounts of debts. What we just showed is that, if debts certainly play a role to facilitate speculation, they are not the only fuel of this activity, which can be financed also from existing profits, with the same potentially destabilizing results.

To conclude on this diversion of profit spending toward assets, its harmfulness comes not only from its capacity - through the rise in speculation, to trigger bubble bursts and financial crises, but also, as Keynes had indicated, from the deficit in demand which it generates on the market for commodities. However what Keynes was pointing out was the reduction in the spending of profits on consumption goods, whereas it should be clear from our models that a reduction in profit spending on the market for fixed capital has similar adverse consequences, and cannot but induce a shortfall in the realization of the product also for fixed capital goods.

This leads us to understand that the role played by profit spending in a crisis situation can have two antagonistic aspects, which need to be underlined in the following principle:

**Principle 39:** An autonomous increase in capitalist consumption financed through money creation can be a remedy to crises deriving from insufficient demand from workers, since it offsets the slump in workers consumption, and results in a higher share of profits. However higher profits may end up being at least partly spent for the purchase of existing assets instead of commodities. This cannot but perpetuate the insufficiency in demand for commodities and trigger speculation, which has been shown to be at the origin of financial crises.

## 3.2. Another remedy for crises: autonomous investment and the Keynesian multiplier

Chapter 10 “The marginal propensity to consume and the multiplier” of Keynes “General Theory” has popularized the idea that it is possible to define an investment multiplier *k*, such that an autonomous increase in investment Δ*I* will create an increase in output Δ*Y*, so that Δ*Y* = *k* Δ*I*, with *k* linked to the marginal propensity to consume *c* by the following relation:

*c* = 1 - 1/k, which is equivalent to *k* = 1/(1-c) (Keynes, 1936, p. 78).

Therefore an obvious remedy to a situation of insufficient demand is for the State or a monetary authority to finance from money creation an additional investment, which is autonomous in the sense that it is not induced by the expected demand of capitalists, a demand supposed anyway to be insufficient to create full employment. This autonomous investment will increase both employment and income.

This idea may appear quite sound, but it is easy to show that the multiplier is not $k = \frac{1}{1-c}$, because in any case *k* is always equal to 1. This demonstration has already been made by Bernard Schmitt, in several of his books. It appears in particular in “Macroeconomic Theory -
A Fundamental Revision”, which he published in 1972. But the corresponding demonstration is quite a lengthy one, since it takes more than 30 pages and involves the concepts of “nominal money” and “real money”. “Nominal Money and Real Money” is also the title of chapter III of this book, where in section A - Positive Analysis, the author discusses the multiplier (Schmitt, 1972, pp. 123-156). But these particular concepts are not necessary from our point of view to achieve the desired result. We will briefly show that the demonstration is much simpler on the basis of our models, using the mechanism of the widow’s cruse.

These models showed indeed that money created by banks at the beginning of a production cycle corresponds initially to the money value of the product, when it is paid to workers in the form of wages, which are a primary income. However we have seen that when incomes are spent on whatever type of commodities, the purchasing power of money in terms of the value of the purchased products, or realized value, is reduced by the levy of profits, which are a transfer income: this is the mechanism behind first the creation of surplus-value, and second its subsequent distribution among capitalists.

Therefore when an autonomous investment, as an additional spending on fixed capital (or in fact on any type of goods, be they fixed capital or consumption goods) takes place, the value which is realized through the purchase is lower than the amount of money spent in exchange for the commodities which are bought. If we call $I_a$ this autonomous investment and if $u_1$ is the ratio of wages $w_1$ to the price of the products $p_1$ bought in this initial purchase, we have

$I_a = p_1$. Then this price is $\frac{1}{u_1}$ times the corresponding value $v_1 = w_1$, and the transferred income, i.e. the profit realized from this initial transaction, is $(1-u_1)p_1$. Once this amount of money $I_a = p_1$ is spent, its purchasing power has thus been used for an amount equivalent to the realized value of the purchased commodity, i.e. $w_1 = u_1p_1$, and it cannot be used again: it is so because the corresponding amount of money has to be repaid to the banks from which it had been borrowed by the firms, at the beginning of the production process, in order precisely to pay the $w_1$ amount of wages of the workers employed by these firms.

As a second step, these profits corresponding to an amount $(1-u_1)p_1$ are used to buy other products for an identical amount, but only a fraction $u_2$ of their purchase corresponds to a realized value, and so on and so forth. In order to simplify the demonstration, let us consider temporarily that the ratio of the value realized on the occasion of each of these successive transactions is constant and equal to $u_1$. Then the series of realized values is:

$$ \Sigma \text{ realized values} = u_1 p_1 + u_1 (1-u_1) p_1 + u_1 (1-u_1)^2 p_1 + \dots + u_1 (1-u_1)^n p_1, \text{ which gives:} $$

$$ \Sigma \text{ realized values} = u_1 p_1 \left[ 1 + (1-u_1) + (1-u_1)^2 + \dots + (1-u_1)^n \right] \quad (1) $$
This is the sum of a geometric series of first term 1 and of constant ratio $(1-u_1)$. We know that the sum of a geometric series is finite as long as the absolute value of the constant ratio is less than 1 (which is the case), and $n$ goes to infinity. This sum is therefore:

$$ \Sigma \text{ realized values} = u_1 p_1 \left( \frac{1}{1-(1-u_1)} \right) = u_1 p_1 \frac{1}{u_1} = p_1 \quad (\text{QED}) \quad (2) $$

Thus the total amount of the sequence of realized values is $p_1$: this newly created value corresponds exactly to the initial spending of $I_a = p_1$, which demonstrates that the multiplier is equal to 1. What is nevertheless true is that this sum of realized values is higher than the amount $w_1 = u_1 p_1$ of the initial wages corresponding to the first purchase made from this spending, because equation (1) can also be written:

$$ \Sigma \text{ realized values} = w_1 \left[ 1 + (1-u_1) + (1-u_1)^2 + \dots + (1-u_1)^n \right] \quad (3) $$

This in turn gives us:

$$ \Sigma \text{ realized values} = w_1 + w_2 + w_3 + \dots + w_n, \text{ corresponding to:} \quad (4) $$

$$ \Sigma \text{ realized values} = \frac{w_1}{u_1} = p_1 \quad (5) $$

Obviously in the real world, as previously indicated, there is absolutely no chance to have parameter $u = u_1$ as a constant. There are on the contrary as many $u_i$ parameters as there are firms and successive stages of spending for the amount of money put in circulation by the initial autonomous investment. But what is important is that the values of these $u_i$ are always lower than 1, which is a sufficient condition for the series to converge to a limit. This limit in any case cannot be higher than the money value of the additional product, i.e. the amount of wages paid out for its production, which themselves are equivalent to the initial injection of money corresponding to the autonomous investment.

Why then are so many economists thinking that the multiplier is higher than 1? For instance if the marginal propensity to consume $c$ is 0.75, they consider that the multiplier is $k = 4$, because we are supposed to have $\Delta Y = \frac{1}{1-c} I_a = kI_a$. The reason behind such a mistake is that they do not understand that the purchasing power of income cannot be kept and transmitted indefinitely, but on the contrary disappears through the spending of income on real goods or services produced during the same period. This period corresponds to that of the payment of primary incomes for this production, and the levy of transfer incomes. These economists do not understand either that the incomes which are transferred in the form of profits on the occasion of each transaction also lose a part of their purchasing power at each subsequent transaction, exactly like primary incomes, and cannot realize a value equivalent to the price of
the goods and services which they obtain. These repeated leakages explain indeed that a series
of purchases cannot go one indefinitely, but on the contrary converges toward a maximum
amount that cannot be greater than 1 compared to the initial purchase.

If we stay in the real world it must also be understood that this multiplier equal to unity is in
fact an upper limit, which in order to be exactly reached would imply that there would be
absolutely no leakages in the course of the successive spending of profits, meaning that all
profits would always be fully spent on real goods and services. But in the real world there are
many reasons, as we saw in the last subsection, for some part of the profits at each stage of
their realization to be diverted to other uses than buying real goods or services, and this is
going undoubtedly to lower below 1 the real effect of the multiplier.

Whatever the precise amount of the multiplier, and even if it is somewhat lower than 1, it
remains that its existence provides a theoretical basis explaining why autonomous investment
may play a useful role as a remedy to insufficient demand. This all the more so that its
corollary is an increase in employment and thus in the creation of value, as long as
productivity remains constant. Indeed investment spending as a spending on fixed capital
implies that additional workers need to be recruited in order to produce this fixed capital,
which creates an additional value. Moreover, once it has been produced and is used in the
production process, a new investment implies the recruitment of additional workers to make it
work, which also leads to value creation, although this will generally happen in a following
period.

More generally autonomous spending can lead to the creation of additional value, if it takes
place independently of any reduction in wages or in employment. Then it does not substitute
to a reduction in the consumption of workers, because it triggers the production of additional
goods and services, implying also the recruitment of additional workers.

The understanding of these mechanisms provides us with possibility to express a new
principle.

**Principle 40:** As Keynes had understood, autonomous investment financed by money creation is the most effective tool to help an economic system out of a crisis. However Keynes, like his followers, was wrong in thinking that it would trigger a net multiplier effect such that the outcome in terms of product would be higher than 1. Because of leakages due to the existence of transfer incomes at each stage of spending, the overall amount of the multiplier between autonomous investment or spending and the corresponding product cannot be greater than 1.

4. Crises and evolution of the rate of profit

We only briefly evoked so far the mechanism at the origin of financial crises, on which we are
not going to elaborate, because it is not the object of this book. We also highlighted the main
mechanism at the origin of “real” crises, i.e. to summarize it briefly the contradiction between
the effect of pursuing increased profits at micro-economic level and its outcome at
macroeconomic level, where it results in insufficient demand. Having identified these
mechanisms, and some potential remedies, we could stop here, if there was not an important
economic literature regarding the Marxist explanation of crises linked to "the law of the
tendency of the rate of profit to fall", which is exposed, under this very title, in part III of
volume III of "Capital" (Capital, 1894, pp. 153-186).

The first chapter of this part of “Capital” (chapter 13) exposes “the law as such”, the
following chapter addresses “counteracting influences”, and the third and last one is devoted
to the “exposition of the exposition of the internal contradictions of the law”.

There are a number of controversies on this question, not only between Marxists and anti-Marxist economists, but even between Marxist authors. Some of this literature has been devoted to confronting theory with the empirical measurement of the rate of profit and its evolution. Since this book is not primarily an empirical analysis, we will not touch upon this aspect of the question. Moreover, we showed that the rate of profit in our theoretical framework is, as a ratio, nothing more than a resultant, and anyway a statistical average of a multiplicity of profit rates. As such one could easily infer that it should not play such an important role in the functioning of the capitalist mode of production.

However, the question has been the object of so much debate among economists that it has
undoubtedly some theoretical interest. All this justifies our view that it should be dealt with
theoretically before trying to connect its evolution to crises and the reproduction of the mode
of production. A theoretical approach is also needed before any empirical attempt at
measuring the profit rate and its evolution, as a prerequisite for the understanding of the
results which these attempts may deliver. This is the reason why we chose to devote the next
and last chapters of this work to a purely theoretical point of view, based on the results
already achieved regarding the nature and measurement of the rate of profit and its evolution.

References

Flamant, Christian (1977). *Hypothèses et concepts dans les théories du capital, de la valeur et de la répartition - Essai d'analyse sémantique* (Assumptions and concepts in the theories of value, capital and distribution - An essay in semantic analysis). PhD Thesis. Paris : University of Paris I - Panthéon-Sorbonne.

Keynes, John Maynard (1936). *The General Theory of Employment, Interest, and Money*. Cambridge (UK): Cambridge University Press.

Malinvaud, Edmond (1969). *Leçons de théorie microéconomique*. Paris: Dunod. Revised English edition: Malinvaud, E. (1985). *Lectures on Microeconomic Theory* (translation: Silvey, A.). Amsterdam, New-York: North-Holland.

Say, Jean-Baptiste (1803). *Traité d'Economie politique*. Paris: Crapelet. English edition: Say, J.-B. (2001). *A Treatise on Political Economy, or The production, distribution, and consumption of wealth*. (translated from the fourth edition of the French by Prinsep, by C. R.). Kitchener (Canada): Batoche Books.
Schmitt, Bernard (1972). *Macroeconomic Theory: A Fundamental Revision*. Albeuve (Switzerland): Castella.

Schumpeter, Joseph (1942). *Capitalism, Socialism and Democracy*. Fifth edition 1976.
London: George Allen & Unwin. Published in the Taylor & Francis e-Library, 2003 [online].
Available at:
https://eet.pixel-online.org/files/etranslation/original/Schumpeter,%20Capitalism,%20Socialism%20and%20Democracy.pdf
Accessed 21 Jul 2018.
# Chapter 18. The Marxist definition of the rate of profit in the simple model

Before Marx, the question of the long run evolution of the rate of profit and its influence on accumulation was not so controversial, since, as recalled by Tsoulfidis “Many of the great economists, including Adam Smith, David Ricardo, John S. Mill and Joseph Schumpeter, accepted the tendency of the rate of profit to fall and associated with this fall economic crisis as one of basic stylized facts of the evolution of capitalist economies” (Tsoulfidis, 2006, p. 65). But, as we indicated previously, the origin of present controversies is the Marxist law of the tendency of the rate of profit to fall. In order to examine it, we will proceed on a step by step basis, which justifies first to dedicate this chapter to the definition and calculation of the rate of profit, before dealing with its evolution in the following chapter. We will start here by recalling briefly the main thrust of Marx’s argumentation, using the simple model which was developed previously.

## 1. Some reminders on the tendency of the rate of profit to fall

On a preliminary basis, since we will return more precisely to these different notions, let us recall first of all that the rate of profit r is defined in the Marxist analysis purely in terms of values, and not in terms of prices. Marx deals with this question in chapter 3 “The relation of the rate of profit to the rate of surplus-value” of volume III of “Capital”. There he indeed defines the rate of profit as the ratio of surplus-value S over the sum of constant capital K and what Marx calls variable capital V, i.e. the value of labor-power (because he considers the latter as being also advanced):

$$r = \frac{S}{K+V}, \quad \text{which can be written:} \tag{1}$$

$$r = \frac{\frac{S}{K}}{\frac{V}{V} + 1} \tag{2}$$

It should be noted that we prefer to use letter K, rather than C, as the symbol representing constant capital, since C has already been used to represent consumption, and will continue to be used as such.

Let us recall also that within the framework of Marxist analysis, constant capital is composed of fixed capital - buildings, machines, beasts of burden - which serves for several periods of production, but which, in each, is incorporated into the value of the product only for a part of its own value (in relation to its own wear), and of circulating capital - raw materials, fuel, lighting - which, in each period of production, disappears to be incorporated in full, as well as
its value, in the new product. Marx calls them constant because the *value* of equipment and
materials being used in production is conserved and transferred to the new product.

For Marx, the rate of profit is therefore calculated not only over the value of fixed capital, but also over the value of intermediate goods, because this last value is supposed also to be advanced, like in the theory of production prices, and finally – as we already mentioned it, on the value of labor-power, for the same reason.

However, in all the following analysis, we will not use the Marxist concept of constant capital, and will only keep fixed capital at the denominator of the expression giving r, for two reasons (a third reason will be added in section 2 of this chapter):

1) First, for an empirical reason: because intermediate goods cannot be considered as advanced for an equivalent and constant period for all of these goods. This period is indeed different from one good to another, depending on various technical factors: it means that the stock circulation rate differs. Certainly for this straightforward and quite obvious reason the current accounting practice does not put intermediate goods at the denominator for the calculation of a rate of return.

2) Second, for a theoretical reason: when all of the intermediate commodities are nevertheless considered as advanced for a similar period of time, like in the theory of production prices, we have demonstrated at length in the first part of this book that this theory was not a coherent one, because it is based on the postulate that there is a surplus of intermediate goods (a condition for profits to appear), whereas as we have shown it is theoretically impossible to demonstrate that there is such thing as a surplus of these goods.

As for variable capital, it corresponds for Marx to the value of living labor employed in the production process, a value considered by him as advanced in the form of wages, which corresponds to what he calls the value of labor-power. Here too one could reject the idea that wages are advanced, and anyway if they are, it is only for quite a short period (one week or at most one month). However the full law of the tendency of the rate of profit to fall is based in Marxist theory on the increase in the organic composition of capital, and this last concept cannot be defined without keeping V at the denominator of the expression giving the rate of profit. If we want to test the Marxist law, even if we do not agree on this Marxist way of calculating this rate, we are therefore obliged, at least temporarily, to stick to Marx's definition, which we will do in the present chapter and the two next ones.

Now that these points have been specified, and on the basis of the above definition, two hypotheses are then necessary for Marx to demonstrate the law of the tendency of the rate of profit to fall:
- the first one is that there exists in the capitalist mode of production a tendency to accumulate, linked to the competition between individual capitals, which results in the increase of the organic composition of capital, which is by definition equal to $q = \frac{K}{V}$;

- the second one is the constancy of the rate of surplus value $k = \frac{S}{V}$ or at least the idea that a rise in this rate would come up against limits such that $\frac{S}{V}$ increases less rapidly than $\frac{K}{V} + 1$;

The important point in the demonstration is anyway the fact that the evolution of $\frac{S}{V}$ and the evolution of $\frac{K}{V}$ are supposed to be relatively independent, even if some feedbacks are admitted between the two rates (for example the rise of $\frac{K}{V}$ can lead to a fall of $V$ and a higher rate of surplus-value $\frac{S}{V}$), which explains why the decline in $r$ can be countered, and why the law is for this reason only a “tendency”.

As we have indicated, this definition of the profit rate by Marx - with $V$ at the denominator of the ratio giving the profit rate, is not the only possible one. Another one will prove to be more relevant anyway. However, and whatever the definition, we will always have the stock of fixed capital at the denominator of the ratio. The measurement of this stock is therefore of the essence, and this question will be addressed first, in the next section of this chapter.

## 2. Measuring the stock of fixed capital

In order for all of the terms in ratio $r = \frac{S}{K+V}$ giving Marx’s rate of profit to be determined, the $K$ value of the total fixed capital stock in use over the production period has yet to be determined precisely, which we did not do so far. This capital is indeed the result of an accumulation made in previous periods, which raises the question of whether it is necessary to take into account depreciation, and of the nature and extent of this depreciation.

We recall that in our theoretical framework, and as a dimension of fixed capital, value cannot be “lost” to be transmitted to the value of the product, whereas fixed capital itself is not materially transformed into the product.

Taking thus into consideration the lack of transmission of the value of fixed capital to the product, depreciation can be defined not in theoretical and economic terms but more empirically as the accounting practice by which capitalists record what they deem to be the loss of value sustained by fixed capital when part of this capital comes out of the production process - after having been used there. It is thus the practice by which capitalists transfer to workers or more generally to buyers of their products the charge of the replacement of this capital, this depreciation being included in the price of the product, as a part of profits. It is
indeed supposed to be equivalent to the difference between gross and net profits, or gross and net operating income, in national accounts.

If we call *t* the duration of use of fixed capital, which can be considered as its average lifespan in a situation of simple reproduction, the capital stock *K* in function necessarily loses each year a fraction of its value which corresponds to the capital put in service *t* years ago, which has therefore reached the end of its lifespan *t*, and which therefore definitively leaves the production process by ceasing to be used, and therefore is discarded (or scrapped), to be replaced by newly produced fixed capital.

This makes it easy to calculate the value of the whole fixed capital stock, called *K*, which after being accumulated during previous periods, is in operation during each period. Its newly accumulated value in simple reproduction is indeed identical from period to period and equal to $I_i$, by calling *i* any current period. If we suppose that the new fixed capital $I_i$ is put into operation at the beginning of each period, and during *t* periods, *t* being the average lifespan of fixed capital, we obtain the following equation:

$$K = \sum_{i=1}^{i=t} I_i = I_1 + I_2 + \dots + I_t = L_t$$ (3)

Since we are in a regime of simple reproduction, and in a situation without capitalist consumption, we have $I_i = S = L_i$, then:

$$K = St = L_t t$$ (4)

On the other hand, if one imagined that each generation of the capital stock $K_i$ in operation during a period *i* loses a fraction of its value inversely proportional to its lifetime, this would have a consequence similar to the introduction of a linear depreciation of this capital. Fixed capital would then lose value continuously, but this would imply that its effective life is known in advance, and implicitly imply the transmission of lost value, something which we have rejected. Nevertheless, and by way of illustration, in this case capital $K_i$ would be accounted for at its residual value, net of amortization, as soon as the end of its first period of use, and we would obtain:

$$K = \left( I_1 - \frac{1}{t} I \right) + \left( I_2 - \frac{2}{t} I \right) + \dots + \left( I_t - \frac{t-1}{t} I \right)$$ (5)

When performing the calculation the expression becomes:

$$K = I_t \frac{t-1}{2}, \text{ that is, if we take } T = \frac{t-1}{2}$$ (6)

$$K = I_t T$$ (7)
$$ \text{That would give in this context } K = S \frac{t-1}{2} = L_I \frac{t-1}{2}, \text{ or } K = L_I T \qquad (8) $$

Instead of $K = L_I t$ (see equation 4)

Having reached this point, and since we are studying Marx's conception of the profit rate, the reader could raise an objection concerning what happened of circulating capital (i.e. the value of intermediate commodities) which is supposed also to be a part of K, as a component of constant capital. In fact, apart from the two reasons already mentioned above in section 1 (p. 348) there is a third and obvious reason not to include circulating capital in constant capital: it is that in our models and at macroeconomic level where we stand, each section is integrated, in the sense that each section produces, with the aid of fixed capital and labor, the totality of circulating capital, i.e. all of the intermediate goods necessary for the production of final goods (see sub-section 3.1. of chapter 11, p. 203). This means necessarily that values which appear in the models are only the values of final commodities, because the value of circulating capital is already included into the value of these final goods, which are $L_I$ for fixed capital and $L_{II}$ for consumption goods. Therefore it would not be logically coherent to count it again a second time in the value of K.

Going back now to the question of the transfer of value, there is clearly a significant divergence in the way capital stock K is measured, between an analysis based on values, in which the transfer of value of fixed capital has been abandoned because it is illogical, and a conception based on the accounting practice of depreciation, which is implicitly based on the notion of transmission of value of fixed capital, assumed to correspond to a continuous loss of this value over time.

Although this latter conception is consistent with Marx's analysis of Capital, it is the source of insurmountable theoretical problems, as we already showed, since depreciation in its accounting sense is necessarily different from depreciation in its economic sense. To be convinced of that let us only ask ourselves how to take into account the transfer of value of a fixed equipment already amortized in the accounting sense, but which continues to be used in the production process, because its actual economic lifespan is greater than its accounting and purely conventional lifespan (a situation which corresponds moreover to the most frequent case). These intractable difficulties explain why this conception of the value of fixed capital stock is not retained in the model presented in this analysis.

Let us note that what is known at a given moment, for example at the beginning of a new production cycle, is the original value of the different elements of fixed capital in use during this cycle, and their date of entry into operation, from which one can derive the average lifespan of this fixed capital up to that moment, since it is an historical and given data. On the other hand, the total lifespan of the various elements of this fixed capital is unknown because it will depend on many factors, such as: