As everyone knows, the whole point of a capitalist economy is to make a profit -- to sell things for more than their total costs of production. And profit alone is not enough. For capitalism to function, profit must become new capital, be re-invested and generate still more profit, creating still more capital. All this seems pretty simple, if we are looking at a single capitalist, or a single corporation.
But if we look at the entire world capitalist economy, things look different. How can all capitalists, capitals as a whole, make a growing profit? The world economy is complicated, so let's first simplify it as much as possible. Imagine an island, with two capitalists, each having, say two workers. The first capitalist, call him General Mills, is an agro-businessman and employs his workers to grow wheat. The second, General Harvester, is a manufacturer and employs his workers to produce plows.
General Mills pays $200 a year in wages and has to buy $200 worth of plows each year, so to make a profit he prices his crop at $700 with the $300 above expenses going to his own consumption plus profit. General Harvester also pays $200 in wages, doesn't need much in the way of equipment, so he sells his years' production of plows for $500, with again a $300 profit. The workers spend their whole $400 wages on wheat.
But, at the end of the year, a crisis develops. General Harvester finds that he's only sold to General Mills $200 worth of plows -- the other three fifths of his production is unsold, and he has no profit at all -- not even enough to live on. General Mills is in the same fix. He has sold $400 of wheat, made no profit at all, and has $300 worth still on hand. He at least can eat some of it, but he can't make a profit either.
Multiply this little picture a hundred million times over, with many capitalists and millions of workers and, in a world of only capitalists and workers, profit is simply impossible. Capitalists invest their capital in the means of production -- the factories that make goods, the railroads that carry them, in raw materials, and in the means of consumption -- the goods needed to support a work force --housing, clothing, food, and so on. These means of consumption are not bought directly but are instead paid out in the form of wages to workers, who then buy these means of consumption. In the process of production, when the workers work in the factories and in the essential services like energy and transportation that support of production, what gets produced is, first of all, those goods necessary to replace those used up in the production process. This is first, the means of consumption that have been consumed; second, the raw materials -- iron ore, coal, oil ; and third; the means of production that have become worn out and must be replaced -- worn out machinery, dilapidated plants. But, in a functioning "normal" capitalist economy, something more had been produced -- a surplus of goods, both means of production and means of consumption that can go into expanding production, building new plants, hiring more workers. Once the entire product has been sold, the cost of the product is spent on replacing the means of consumption and production that have been used up, and the difference -- the money equivalent of the surplus-- is profit. This profit, together with the old capitals is reconverted into goods to start another, expanded cycle of production.
The problem is: how can this surplus be sold? Workers can buy the means of consumption , the capitalists themselves buy the replacement raw materials and means of production, but who buys the surplus? Workers have no income except the wages they get from capitals and how can capitalists make a profit from the money they themselves lay out? Nor can the capitalists make a profit by selling to themselves. Sure, one capitalist can gain at the expense of another's losses but there can be no overall net profit. Yet in the real world, in general there is a net profit for all capitals. Who, then, buys the surplus -- where does the profit come from?
The solution, as the socialist economist and revolutionary Rosa Luxembourg first pointed out in 1911, elaborating on earlier ideas of Karl Marx, is that capitalism has never existed in a world of only employers and wage earners. At all times, including today, the largest portion of the world's population is neither -- they are peasants, petty agricultural producers who are not employees, but neither are they capitalists because they don't accumulate capital -- they sell crops just to support themselves and their families. It is this external market that is crucial for the very survival of capitalism.
Taking capitalists as a whole, capital can only cover its costs by selling to itself (capitalists selling to capitalists) or to workers. Ford can sell cars at a profit to GM workers and GM can sell cars at a profit to Ford workers. But collectively, capitalists as a whole can only make a profit to the extent they sell to non-capitalist producers --farmers and peasants, in whatever country they are and other non-capitalist producers, such as state-owned factories. This is, as we'll see, the key to understand the development of capitalism and to the present crises.
Why is selling to non-capitalist producers different? Because they can pay not just with money they receive from capitalists, when they sell their agricultural products, but they have independent sources of wealth -- they possess means of production, their land (or today, state-owned enterprises have their factories). Initially, as capital first penetrated non capitalist areas, it absorbed the previously accumulated wealth of other societies -- of feudal Europe, of India, of China, vast countries that had for centuries settled affairs in gold and money. Second, when this source is exhausted, capital can loan money to these peasants and their governments -- with the collateral being their land and the mineral wealth beneath it. Of course capitalists can lend to workers. But such loans are limited because workers possess and can use as collateral only that which they've bought with capitalist wages -- houses, cars and so on. Nothing can be produced with them, they can just be resold. With non-capitalist layers, however, the land itself is the collateral, and as peasant families, or entire nations default on such loans, capital forecloses, seizing in the process vast real wealth, vast means of producing new wealth.
In our imaginary island example, if we had a population of ten or twenty natives originally living on the island, they first buy surplus plows and grain with their own, anciently accumulated, gold and silver, then they borrow money from General Mills and General Harvester, putting up their land as collateral. When they cannot pay back the loans, their land is lost and they go to work for the capitalists. The capitalists have realized their profit -- that is, sold their surplus -- and have, in return, the islanders' gold and silver and their land. Mills and Harvester then look for the next island.
What is crucial to their process is not just an external, non capitalist market, but an expanding non-capitalist market. Capital only exists to the extent that it grows -- makes a profit. Thus the capitalists have appropriated for themselves, after paying out wages and other costs of production, part of the product that the workers produced --this is the essence of capitalist exploitation of labor. If that fraction of goods is, say 10% of the costs, the initially invested capital, then the rate of profit is 10%. But this means, in turn, that in the next cycle of production, capital is 10% more, production is 10% larger and profit is 10% larger.
So, since the scale of profit realized is limited by sales to the external market, that market must grow and grow at a rate determined by the rate of profit. In rough terms an 10% annual rate of profit means a growth in capital, profit and everything else by 10% a year and thus an increase in the external market by 10% a year.
This necessity for the rapid expansion of the external market has driven the history of capitalism. For expanding the external market means seeking ever new populations of non-capitalist producers. This is because it is not possible to increase the value sold to any given set of peasants without limit. Initial reserves of money, accumulated over long periods of time in non capitalist economies, are soon exhausted. The peasant can raise new income by selling his own surplus product -- food or other agricultural raw materials either to the capitalists, or to other non-capitalist layers -- local townspeople for example. But the peasant's money income is also strictly limited. Even if he is able, with the help of new tools and technologies, to increase productivity and thus the volume of goods he sells, a process that takes time, he will not similarly increase the money value of his product. For as peasants produce more goods, the price of the goods declines. Thus, for example, the volume of grain produced world wide increased by 2.4 times over the past 40 years. Yet the total market value of the grain crop, in constant dollars, has actually fallen by 11%.
Under capitalism, over the long run, the prices of given types of goods are roughly proportional to the labor time (of average productivity) expended in making them. So over the long run, the total value produced by a given population of peasants is limited by the labor time available to them.
The only way to increase this value is for the peasants to increase their productivity over the world average, which is possible for individual groups of peasants, but not for peasants as a whole, since they represent the bulk of the world population.
Thus increasing the external market means increasing the number of peasants in the external market, and increasing it far more rapidly than the slow natural growth of population. Capitalism, in its insatiable drive for markets, forcibly opens to trade nation after nation, through war, revolutions and imperialism. The need for these new markets provides capitalism with its dynamic. And capitalism accelerates this process because it is continually eating away at these new markets. As peasants become progressively indebted, as their land is foreclosed, they are proletarianized, converted to part of the wage work force. So capitalism must be continuously replacing these peasants who are absorbed into the wage earning population, as well as finding new markets for the expansion of capital and production.
But at the same time, this very process of ransacking the earth for new markets provides capitalism with its other needs. By generating an ever growing supply of impoverished peasants forced from the land, capitalism forms a reserve army of labor, which applies downward pressure on all wages, at the same time allowing the work force, in boom times, to grow far faster than natural reproduction. This process is still at work today, as for example, Chinese peasants are driven off the land into factories to make goods for the world market at a fraction of the wages earned in the advanced countries, but in direct competition with their products. Without such a reserve army of unemployed, desperate for work, shortages of labor would have developed as capitalism expanded, forcing wages upwards and profits down.
Second, and equally important, the progressive incorporation of more and more of the earth into the capitalism market provides capital with the raw materials needed for production. Not only was the linen of English textile mills sold to Indian peasants, the cotton for it came from non-capitalist production: the slave plantations of the American South, and later the feudal plantations of Egypt. As more and more land is encumbered with capitalist debt, and subsequently foreclosed, the vast mineral wealth underneath falls into the hands of world capital.
Thus the process of expansion of the external market, the progressive incorporation of non-capitalist layers into that market, is essential for capitalism. And it is at the same time, the Achilles heel that dooms capitalism. For it is impossible to continuously expand the external market. At one point, a point reached some time ago, the entire world was incorporated into the capitalist market and it could no longer expand. At that point capitalism itself could no longer expand and entered a prolonged crisis.