Secular decline in profit rates: time series analysis of a classical hypothesis.

• Author: Trofimov, Ivan D.
• Position: Report

1. Introduction

   The issue of the declining profit rates in the developed economies comes to fore and becomes topical in light of the slowdown in economic growth and the stagnation and crises tendencies that have been evident in the recent years. These tendencies have been discussed mostly within Keynesian, post-Keynesian and Marxist schools of thought, with profit rates' decline being only one of the many reasons of the instability and crisis-prone nature of capitalism, other explanations including under-consumption problem, capitalism's anarchic nature and lack of planning, excessive financialisation, among others (Edvinsson, 2005: 22-3).

   The purpose of this paper is to consider the issue of a secular decline in economywide profit rates as one of the drivers and a background of current economic problems. The possibility of profit rates' decline has been subject to debate among classical (Smith, Ricardo, Marx) and modern (Kalecki, Keynes, Feldstein) economists of both mainstream and heterodox schools. In its classical formulation, the secular decline is attributed to the drive for profits embedded in capitalist system that in turn leads to over-accumulation of capital and thus deterioration of profit rates.

   Specifically, we carry out empirical analysis of profit rates in a sufficiently large sample of economies to establish the patterns and dynamics of the variable and thereby contribute to the debate. The time series analysis is complemented by an exploratory overview of similarities and differences in the profit rates' patterns, and of the likely determinants of the profit rates. A consideration is also given to the limitations of the conventionally used profit rates' indicators.

   The principal distinction of this paper from previous studies is as follows. Firstly, it attempts to consider the largest possible number of economies (both developed and developing, over a range of historical periods), in contrast to previous works that considered one or a handful of economies. Secondly, the paper attempts to use modern econometric techniques for the analysis, in contrast to previous studies that relied mostly on visual observation of the series or simple linear trend estimation. Thirdly, due to the variety of ways to conceptualise profit rate in the whole economy, this paper explores and utilises alternative profit rate measures adopted by classical (specifically Marxist) and neoclassical economists. A uniform set of econometric techniques and instruments was used to analyse such diverse settings and measures.

   In terms of econometrics methodology, we conduct a sequential procedure Using unit root tests (with and without structural breaks) as well as nonparametric Techniques to determine the presence of deterministic or stochastic trends (with or without breaks) and to provide respective trend estimates.

   The balance of the paper is organised as follows. A review of theoretical and empirical literature is contained in Section 2. Section 3 considers general methodological issues, data used in the paper, as well as econometric approach. Empirical results are presented in Section 4. Exploratory analysis is included in Section 5, while Section 6 provides concluding remarks and discusses avenues for further research in the area.

2. Literature review

   The "law of profit" first formulated by K. Marx in 1894 (in the first three chapters of Volume III of Capital) stated that there is a tendency of a secular decline in the rate of profits in a capitalist economy: "With the progressive decline in the variable capital in relation to constant capital, this tendency leads to a rising organic composition of the total capital, and the direct result of this is that the rate of surplusvalue, with the level of exploitation of labour remaining the same or even rising, is expressed in a steadily falling general rate of profit." (Marx, 1894/1981, pp. 318-319) The view of long-term deterioration of profit rates is not universally accepted in economics, with several economists (Keynes, Kuznets) considering it unlikely, while others (Jevons, Smith, Ricardo) arguing in favour of secular decline. Importantly, Marx itself was reconsidering and reformulating "the law of profit" in his later works, arguing that decline in profit rates is not a deterministic process (Reuten, 2004). The "law of profit" thus has a status of hypothesis.

   The theoretical debate as to the possibility and causes of the rate of profit decline has been ongoing. The views range from no tendency of the rate of profit to fall (Okishio, 1961) to secular tendency of the profit rate to fall (Shaikh, 1992) to the absence of any a priori tendencies (Foley, Michl, 1986; Moseley, 1991; Dumenil, Levy, 2003). In terms of determinants of possible decline in profit rates, Gordon et al (1983) pointed to general failure of structures supporting capitalist accumulation; Shaikh (1983) to rising organic composition of capital; Glyn and Sutcliffe (1972) to rising wages; and Baran, Sweezy (1965) to demand side issues. The purpose of this paper is not to engage in theoretical debate about the causes of profit rates' dynamics, but to conduct empirical analysis and attempt to establish certain statistical regularities pertaining to profit rates time series.

   On empirical front, the research of profit rates dynamics has been substantial, considering profit rates dynamics from several angles. The majority of earlier studies was conducted for the US economy and used deterministic trend (with or without exogenous breaks and correction for business cycle) as principal analytical tool.

   Gillman (1957), focusing on US manufacturing sector and not adjusting for profit rates' cyclical variation, Gillman identifies secular deterioration of profit rates from 1880s till Great Depression, thereby confirming classical hypothesis. The study by Lovell (1978) that allowed for cyclical adjustment of manufacturing profit rates but did not include land and inventories in capital stock pointed to deterioration of profit rates in the 1950s and particularly after 1965, followed by sharp increase in the 1970s. The study however did not discover any statistically significant time trends over 1947-77 period.

   Nordhaus (1974), estimating after-tax manufacturing sector profit rate and excluding land from calculation, concluded that profit rates declined during 1948-74. This however included a period of profit rates' rise between mid-1950s and 1965.

   Feldstein and Summers (1977), considered before-tax manufacturing profit rate series over 1946-76 period, included land in the capital base and used various capacity utilization and GDP gap measures to correct for cyclical fluctuations. The results were inconclusive: based on some measures, statistically significant downward time trend was identified, while other measures suggested cyclical fluctuations in series.

   Kopcke (1978) argued that exogenously determined structural breaks in the aftertax manufacturing sector series matter: while no statistically significant trend was identified for longer time series (1947-77), two significant trends with opposing coefficients' signs were identified from 1947-65 and 1965-77 periods.

   Extending the series into 1970s and examining both before and after-tax profit rates and a battery of various cyclical adjusters, Liebling (1979) concluded in contrast to Koepcke that there was no restoration of the profit rates in the 1970s: the profit rates did not rise to the levels of 1950s and 1960s, suggesting that some deeper structural shift in the US economy occurred.

   Allman (1983) looked at both economy-wide and sectoral before-tax profit rates and concluded that secular deterioration of profit rates in the USA over post-war period was pervasive across various industries and sectors.

   More recently, Basu and Manolakos (2013) examined the statistical properties of the US profit rates series over 1869-2007 period and contrasted alternative hypotheses of long-wave cyclical behavior versus secular decline (with countervailing forces leading to temporary profit rates' rises). Analysis utilized Box-Jenkins methodology, firstgeneration unit root tests (Dickey-Fuller and Phillips-Perron), and Lowess trend. The results suggested that US profit rate has been declining on average by 0.3% per annum over 1947-2007 period (accounting for countervailing tendencies). Roberts (2011) obtained the similar estimate of 0.4% average decline in 1947-2009.

   Regarding other economies, empirical studies were conducted for Mexico (Ortiz, 2005), Spain (Camara, 2007), Brazil (Marquetti et al, 2010) and Japan (Alexander, 1998) over post-war period. Analytical methods principally included visual observation or deterministic trends. The results pointed to long-term fall of profit rates (Japan); decline and rebound of profit rate starting from early the 1980s (Mexico); stabilisation of profit rates in 1980-90s (Spain); secular decline with rebound in the 1990s (Brazil).

   In terms of multi-country and comparative studies, Chan-Lee and Sutch (1985) estimated manufacturing profit rates in 11 OECD economies over 1960-1980 period. With minor exceptions for certain industries, decline of profit rates in 1970s appeared to be common. The result was confirmed by Downe (1986): in the study of cyclicallyadjusted rates of return in seven developed economies, the negative and statistically significant trends were present universally.

   Li et al (2007), using world-system model referring to the relative power and hegemony of states on the international arena, considered the long-term profitability for the UK, U.S., Japan and the Euro zone (over 50 year period) and concluded that UK profit rates were characterised by four cycles over last 150 years and downward decline tendencies, with certain stabilisation taking place in 1980-90s. In the US, despite cyclical fluctuation in the series, the long-term trend appeared to be positive. Eurozone and more so Japan were characterised by declining...