Top 6 Theories of Wages (With Criticisms)

The following points highlight the top six theories of wages. The theories are: 1. The Subsistence Theory of Wages 2. Standard of Living Theory 3. Wage Fund Theory 4. Residual Claimant Theory 5. Marginal Productivity Theory 6. Discounted Marginal Productivity Theory.

Theory # 1. The Subsistence Theory of Wages:

The theory was formulated by physiocrats. According to them wages would be equal to the amount just sufficient for subsistence. Lassale, a German economist developed this theory. According to this theory, wages are determined by the cost of production of labour or subsistence level. The wages so determined will remain fixed.

It actual wages are higher than the subsistence level, then population will increase leading to an increase in labour supply and lower wages. If on the other hand, the actual wages fall below the subsistence level, population will decrease resulting in a decline in labour supply and rise in wages. Since there is a tendency for the wages to remain fixed at the subsistence level, it is called as Iron Law of Wages or Brazen Law of Wages.

This theory is based on two assumptions:

1. Food production is subject to the law of diminishing returns, i.e., there is a limit to expansion of food production.

2. Population increases at an increasing rate.

Criticisms:

1. The subsistence theory of wages explains wages from the supply side and ignores the demand side.

2. If all labourers must get the bare necessaries of life, all must get equal wages. But there are many differences in wages. Thus this theory ignores wage differences.

3. This theory asserts that wages are fixed at the subsistence level. Therefore, it assumes that the trade unions are powerless in increasing the wages. This is a wrong notion.

4. This theory is based on the Malthusian theory of population according to which a rise in wages above the subsistence level will lead to rapid increase in population. But experience shows that a rise in wages leads to higher standard of living and not increase in population.

5. This theory is pessimistic because it excludes all possibility of improvement in the conditions of labour either through increased efficiency or due to general economic progress.

Theory # 2. Standard of Living Theory:

This theory is an improved and refined version of subsistence theory. According to this theory, wage is determined by the standard of living of the workers. Standard of living refers to the bare necessaries of life and also education, and recreation to which the worker is habituated.

Merits:

This theory has two merits:

1. This theory gives importance to the efficiency and productivity of the worker.

2. When workers are paid a high wage rate for a considerable period of time, they become accustomed to a high standard of living and they will try to maintain the same high standard of living.

Criticisms:

In spite of its merits, the theory has been subjected to many criticisms:

1. Individuals do not have any fixed standard of living. Critics point out that there is no such thing as a standard of living to which a worker is accustomed.

2. When wages depend on standard of living, the latter should not change. But workers’ standard of living remains fixed for sometimes but wages change frequently.

3. No doubt, wages are determined by standard of living. It is also true that standard of living is determined by wages.

Theory # 3. Wage Fund Theory:

This theory was developed by J.S.Mill. According to him, the employers set apart a certain amount of capital to pay wages for labourers. This is fixed and constant. This is called as wages fund. Wage is determined by the amount of wages fund and the total number of labourers.

According to J.S.Mill, “wages depend upon the demand and supply of labour or as it is often expressed as proportion between population and capital. By population is here meant the number only of the laboring classes or rather of those who work for hire and by capital, only circulating capital……….. “.

Wage rate=Wage fund / Number of labourers

An increase in wage rate is possible only by an increase in wage fund or by a reduction in the number of labourers. Thus there exists a direct relation between wage rate and wages fund and inverse relation between wage rate and number of labourers. This theory also states that trade unions are powerless in rising the general wage rate.

Criticisms:

1. Wage fund theory states that the wage rate is found by dividing the wage fund by the number of workers. But it does not tell us about the sources of wages fund and the method of estimating it.

2. Wage fund theory is unscientific and illogical because it first decides the wages fund and then determines wages. But in reality, wages should be found first and from that wage fund should be calculated. This theory neglects the quality and efficiency of the workers in determining the wage rate. This is considered to be a basic weakness of the theory.

3. This theory neglects the quality and efficiency of the workers in determining the wage rate. This is considered to be a basic weakness of the theory.

4. This theory assumes that wages can increase only at the expense of profit. This is not correct. The operation of the law of increasing returns will lead to a great increase in total output which may be sufficient to raise both wages and profits.

5. The wages fund theory has been criticised by the trade unions for its assumption that wages cannot be increased through bargaining.

6. Wages fund theory has failed to explain the differences in wage rate.

7. This theory believes that wages are paid out of circulating capital. But when the process of production is short, wages are paid out of current production. When the process of production is long, wages are paid out of capital.

Theory # 4. Residual Claimant Theory:

This theory was propounded by Walker. According to this theory, rent and interest are contractual payments. After deducting rent and interest from total product, the employer will deduct his profits. What remains after deducting rent, interest and profits is wages. It is possible to increase wages by increasing the total product by improving the efficiency of the workers.

This theory has several defects:

1. This theory assumes that the share of landlords, capitalists and entrepreneurs are fixed and it is absolutely wrong.

2. It is not the worker who is the residual claimant but the entrepreneur.

3. It does not explain the influence of trade union in wage determination.

4. The supply side of labour has been totally ignored by the theory.

Theory # 5. Marginal Productivity Theory:

Marginal productivity theory of wages is an extension of marginal productivity theory of distribution. According to this theory, wage for labour should be equal to the value of the marginal product under conditions of perfect competition. Marginal product is the addition made to total product by the employment of one unit of labour. The value of the marginal product of labour is equal to the price at which the marginal product can be sold.

Under conditions of perfect competition, an employer will continue to employ more and more of labourers till the value of the marginal product is equal to marginal factor cost(MFC). Marginal factor cost is the cost of employing an additional worker. In order to find out the marginal productivity of labour we have to keep the quantity of other factors constant while employing one more unit of labour.

The difference in total production is the marginal productivity. The employment of an additional unit of labour will result in increase in output and cost. As long as MPP is greater than MFC, the employer will employ additional units of labour. But he will stop employing additional units of labour when MPP=MC.

Assumptions:

This theory is based upon the following assumptions:

1. There is perfect competition in factor market and in product market.

2. Labour is homogeneous.

3. The law of diminishing returns operates in production.

4. There is free entry and exit of the firms.

5. There is perfect knowledge about the market conditions.

6. All factors of production can be substituted for each other.

7. There is free mobility of factors of production.

8. Factors of production are divisible.

Criticism:

The theory is found to be unsatisfactory and various criticisms have been leveled against this theory.

1. The theory deals with the demand side only. The supply side is totally ignored.

2. This theory is unjust because wages are determined by the marginal productivity. But justice demand that workers should be paid on the basis of average productivity.

3. Further, marginal productivity of the worker cannot be calculated as factors are not divisible into small units.

4. Factors of production are neither mobile nor perfect substitutes. Their Knowledge is also imperfect.

5. This theory assumes perfect competition in the product market. But the market for goods is characterised by imperfect competition.

6. Marginal product of labour depends not only on its support but also on the supply of other factors. If other factors are plentiful and labour is scarce, marginal product of labour will be high and vice versa.

7. This theory fails to explain the differences in wages.

Rejecting the marginal productivity theory Marshall states, “This doctrine has been put forward as a theory of wages. But there is no valid ground for any such pretension… Demand and supply exert equally important influences on wages; neither has a claim to predominance; any more than has either blade of scissors, or either pier of an arch… The doctrine throws into clear light, one of the causes that governs wages”.

Theory # 6. Discounted Marginal Productivity Theory:

Taussig has given a modified version of the Marginal Productivity theory of wages. According to this theory, the wage for labour is determined not by its marginal product but by the discounted marginal product. Labourers cannot get the entire amount of the marginal product because production is a long drawn out process.

In the same way, sales also take time. As the labourers are poor and cannot wait till the product is sold, they have to be supported by the employers. The employer does not pay the full amount of the marginal product of labour. In order to compensate the risk involved in giving advance to the workers, the employer deducts a certain percentage from the final output. This deduction is made at the current rate of interest. It is the discounted marginal product that determines the wage of the labourers.

Criticisms:

1. This theory is abstract. It is “a dim and abstract one remote from the problem of real life”.

2. It is very difficult to determine the discounted marginal product of labour.

3. This theory fails to take into account other factors which determine the wage rate.

4. This theory has failed to explain differences in wage rate.

Taussing’s theory is another version of the Residual Claimant Theory of wages. Therefore, it is subject to all criticisms put forward against the Residual Claimant Theory.