Concepts of organic composition of capital
Karl Marx modified the classical picture once again. For “modern” growth theory, Marx’s achievement was critical because he not only provided, through his famous “reproduction” schema, but he did so in a multi-sectoral context and, in the process, contributed critical ingredients such as the concept of a “steady-state” growth equilibrium. He explains how a particular capitalist economic system functions.
Marx’s theory differed from the earlier classical economists in many ways. Firstly, unlike Smith or Ricardo, Marx did not believe that labour supply was endogenous to the wage. As a result, Marx had wages determined not by necessity or “natural/cultural” factors but rather by bargaining between capitalists and workers.
This process however was considered to be influenced by the amount of unemployed labourers in the economy (the “reserve army of labour”, as he put it). Marx also argued profits as the determinants of savings and capital accumulation.
Like the classical economists, Marx believed there was a declining rate of profit over the long-term. The long-run tendency for the rate of profit to decline is brought about not by competition increasing wages (as in Smith), nor by the diminishing marginal productivity of land (as in Ricardo), but rather by the “rising organic composition of capital”.
Marx defined the “organic composition of capital” as the ratio of what he called constant capital to variable capital. It is important to realise that constant capital is not what we today call fixed capital, but rather circulating capital such as raw materials.
Marx uses his theory of surplus value as the economic basis of the ‘class struggle’ under capitalism and it is on the basis of his theory of surplus value that he builds the superstructure of his analysis of economic development.
Class struggle is simply the outcome of accumulation of surplus value in the hands of a few capitalists. Capitalism, according to Marx, is divided into two great protagonists: the workers who sell their ‘labour-power’ and the capitalists who own ‘the means of production.’ Labour power is like any other commodity.
The labourer sells his labour for what it is worth in the labour market, viz., for its value. And its value, like the value of any other commodity, is the amount of labour that it takes to produce labour-power.
In other words, the value of labour-power is the value of the means of subsistence necessary for the maintenance of the labourer, which is determined by the number of hours necessary for its production.
According to Marx, the value of the commodities necessary for the subsistence of the labour is never equal to the value of the produce of that labour. If a labourer works for a ten-hour day, but it takes him six hours’ labour to produce goods to cover his subsistence, he will be paid wages equal to six hours’ labour.
The difference worth 4 hours’ labour goes into the capitalist’s pocket in the form of net profits, rent and interest. Marx calls this unpaid work “surplus value.” The extra labour that a labourer puts in and for which he receives nothing, Marx calls “surplus labour.”