10 Theories of Wages

10 Theories of WagesSound wage theories address itself to questions such as adequacy of wages, fairness, and equity, hard working conditions and efforts, compensation against inflation, and additional commitment of employees as he grows up to rear family, etc. try to explain the major wage theories.

  1. Subsistence Theory.
  2. Wage Fund Theory.
  3. Surplus Value Theory.
  4. Residual Claimant Theory.
  5. Marginal Productivity Theory.
  6. Demand and Supply Theory.
  7. Bargaining Theory.
  8. Behavioral Theory.
  9. Just Price Theory.
  10. Investment Theory.

The main theories of wages are discussed below:

1. Subsistence Theory

David Ricardo developed this theory. It is also known as the iron law of wages. It says that workers are paid to enable them to subsist and perpetuate the race without increase or diminution.

Low wage leads to decrease of labor due to death and malnutrition, while higher wages increase their number due to better health, long life, and more marriage.

This theory has been criticized on the following grounds:

  1. The relation between marriages and wages. It is incorrect to say that when the money income of a person increases about the subsistence level, he marries and increases the birth rate. While in fact, when income increases, people improve their standard of living instead of having the marriage.
  2. Demand-side ignored. This theory gives more importance to the supply side and ignores the demand side of labor, for the determination of wages.
  3. The difference in wages. This theory fails to explain why wages differ from occupation to occupation and from person to person.
  4. Trade unions ignored. This theory ignores the role of trade unions. But in the present age unions are playing a very important role in the determination of wages.

2. Wage Fund Theory

Adam Smith developed this theory. The wage level is a function of surplus fund available’ with the employer. Higher the fund, higher the wage. The focus is on the employer and his capacity to pay.

This theory has been criticized on the following grounds:

  1. The difference in wages. According to this theory, all the workers receive equal wages while in fact, wages differ from worker to worker.
  2. Demand factor ignored. In this theory supply of labor has given much importance while the demand factor has been ignored.
  3. Existence of fund. According to this theory, there is a separate fund for the payment of wages, while in reality there is no special fund which is particularly meant for the payment of wages to the workers.
  4. Objection on homogeneous labor. This theory assumes that labor is homogeneous and they should be paid equally, but all the units of labor cannot be homogeneous.

3. Surplus Value Theory

Karl Marx developed it. Here labor is viewed as a commodity for trade.

Labor adds value to the product. The employer did not pay the full amount so collected from the customer and instead only a part is paid to them as wage, retaining the remaining by the employer.

In Marx’s estimation, it was not the pressure of population that drove wages to the subsistence level, but rather the existence of a large number of unemployed workers.

Marx blamed unemployment on capitalists. He renewed Ricardo’s belief that the exchange value of any product was determined by the hours of labor necessary to create it.

Furthermore, Marx held that, in capitalism, labor was merely a commodity: in exchange for work, a laborer would receive a subsistence wage.

Marx speculated, however, that the owner of capital could force the worker to spend more time on the job than was necessary for earning this subsistence income, and the excess product-or surplus value-thus created would be claimed by the owner.

This argument was eventually disproved, and the labor theory of value and the subsistence theory of wages were also found to be invalid.

4. Residual Claimant Theory

Francis walker propounded this theory.

According to this theory, four factors add value to the product, which is manufactured. These are land, labor, capital, and entrepreneurship. The revenue earned by selling products was first distributed among the three factors as compensation against their contribution.

Whatever remained was paid to labor as wage against their value addition. Thus labor is considered as a residual claimant. This theory has been criticized on the following grounds:

  1. Supply influence ignored. This theory ignores the influence of the supply side in the determination of wages.
  2. Role of trade unions. It fails to explain as to how the trade unions raise their wages.
  3. Entrepreneur right. A residual claimant is the right of entrepreneur and not the labor. The labor receives its share during the process of production.
  4. Case of loss. If the firms suffer a loss, in that case, how labor will bear the loss.

5. Marginal Productivity Theory

This theory was developed by Phillips Henry Wicksteed and John Bates. Here demand and supply of labor in the labor market determine wages.

Accordingly, workers are paid what they are economically worth as assessed by the employer.

The marginal concept says that the employer continues to employ labor as long as value addition by the marginal worker is more than his cost. The result is that the employer has a larger share in the profit as has not to pay the non-marginal workers.

6. Demand and Supply Theory

Just as the price of a commodity is determined by the interaction of the forces of demand and supply, the rate of wages can also be determined in the same way with help of demand and supply forces.

Supply of labor depends upon the factors such as the size of the population, mobility of labor, and social structure. The wages will be determined at the point where demand and supply both are equal to each other.

7. Bargaining Theory

John Davidson developed this theory.

Here wage level is determined by the bargaining power of employers and their association vs employees and their trade unions.

8. Behavioral Theory

Norms, traditions, customs, goodwill, and social pressure influence the wage structure. Wages are the best motivators for workers.

The wage must satisfy a number of needs as identified by Maslow, Herzberg, and others. Examples of needs are physiological, security, food and shelter, etc.

9. Just Price Theory

This theory, developed by Plato and Aristotle, suggested that each person born into the world be foreordinated to occupy exactly the same status and to enjoy the same creative comforts as did his/her parents.

Therefore, society should provide these individuals with sufficient compensation to maintain exactly the same position of life into which they were born. This theory made no recognition of the differences in productive efficiency between two workers.

10. Investment Theory

H.M. Gitelman developed this theory. The individual workers’ investment consists of education, training, and experience that a worker has invested in a lifetime of work.

Gitelman assumes that a workers’ compensation is fixed by the rate of return on that workers’ investment. Workers can control their level of own compensation.

For example, MBA graduates from Harvard University are likely to be paid more than those of less costly universities in the USA.