Theories of Wages

Everything you need to know about the theories of wages. Wage means “any economic compensation paid by the employer under some contract to his workers for the services rendered by them”. It includes family allowance, relief pay, financial support and other benefits.

In the narrower sense wages are the price paid for the services of labour in the process of production and include only the performance wages.

Wages of every worker has a behavioural objective and seeks to fulfil the survival need (physiological or psychological) to fulfil the goals.

Luthans argues that motivation is a process that starts with a physiological or psychological deficiency or need that activates behaviour or a drive that is aimed at a goal.

The remuneration which workmen receive is termed as wages. Economists look upon wages as a payment to one of the factors of production for its contribution to the production process.

The first wage theory known as the Subsistence Theory of Wages was developed by the English economist David Ricardo in 1817.

Wages are fixed mainly as a result of individual bargaining, collective bargaining or by public or State regulation. How wages are determined has been the subject of several theories of wages.

The theories of wages can be studied under the following heads:- 1. Behavioural Theories 2. Economic Theories.

Some of the behavioural theories are:- i. Content Theories ii. Process Theories iii. Contemporary Theories iv. Equity Theory v. Vroom’s Expectancy Theory vi. Herzberg’s Two-Factor Theory.

Some of the economic theories are:- i. Subsistence ii. Wages Fund iii. Residual Claimant iv. Marginal Productivity v. Taussig’s vi. Demand and Supply vii. Surplus Value viii. Bargaining ix. Purchasing Power x. Modern Theories of Wages.

Few other theories of wages are as follows:- i. Karl Marx’s ii. Residual Claimant iii. The Just Wage Theory iv. Standard of Living Theory.

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Theories of Wages – Behavioural Theories, Economic Theories and a Few Other Theories

Theories of Wages – 3 Categories of Behavioural Theories: Content, Process and Contemporary Theory

Behaviour means natural reaction or movement to the environment and yourself. Motivation is the process of attempting to influence others to do your work will through the possibility of gain or reward.

Wages of every worker has a behavioural objective and seeks to fulfil the survival need (physiological or psychological) to fulfil the goals. Luthans argues that motivation is a process that starts with a physiological or psychological deficiency or need that activates behaviour or a drive that is aimed at a goal.

Compensation policy are targeted at rewarding manpower for their skill, talent, performance, effort, responsibility and working conditions and increase their morale for efficient performance.

Behavioural theories are divided into three categories:

1. Content theories

2. Process theories, and

3. Contemporary theories

Category # 1. Content Theories:

The content theories explain what inspires manpower at their jobs. Maslow, Herzberg and Alderfer gave their significant contribution to content theories.

These are as follows:

i. Hierarchy of Needs:

Abraham Maslow proposed the first theory called the hierarchy of needs theory. He proposed five needs of any people in needs hierarchy. These are physiological or basic need (food, shelter, clothing), safety need (emotional and physical safety – health insurance, pension), social need (affection and belongingness to society), Self-esteem need (power, achievement, status, etc.), and self- actualization (personal growth, realization of potential).

Maslow believed that within every individual, there exists a hierarchy of five needs and each level of need must be satisfied to a certain extent before an individual pursues the next higher level of need. As individual progresses through the various levels of needs, the preceding needs lose their motivational value.

ii. Two Factor Theory of Motivation:

Herzberg extended work of Maslow and developed a specific content theory of work motivation.

Factors of this motivational theory divided into two categories:

a. Intrinsic:

Intrinsic factors are the motivators (satisfiers) for the workforce and, Extrinsic factors are the hygiene factors (dissatisfiers). Intrinsic remuneration works for satisfying workers related to job content. It includes success, identification, responsibility, work enrichment, and work enlargement.

b. Extrinsic:

Extrinsic remuneration is hygiene factors and helps to reduce the dissatisfaction on the job. It includes company rules, regulation and administration, supervision, co-ordination, salary structure, interpersonal relations, and working environment.

iii. ERG Theory:

Clayton Alderfer identified three groups of core needs; they are- Existence, Relatedness and Growth.

(a) The existence needs are concerned with survival.

(b) The relatedness needs are the importance of interpersonal and social relationship.

(c) The growth needs are concerned with individual’s intrinsic desire for personal development. Based on a person’s background and social environment, one set of needs may precede over others.

The job of Maslow, Herzberg and Alderfer are related to content theories. They give useful theories but have limited implications for policy and practice.

Category # 2. Process Theories:

Process theories were examined by performance of Vroom (on valence and expectancy) and Porter and Lawer (performance- satisfaction linkage). They look at the related proceedings that go into motivation or effort, particularly the way they relate to one another.

Expectancy Theory:

Victor Vroom developed expectancy theory under process theory based on the abstract of valence, expectancy and instrumentality.

Valence states to an individual’s orientation for an individual result. For instance, most old employees perceive value benefits against fewer, if any, younger employee in today’s knowledge industry.

Single (unmarried) workers with fewer family responsibility have less or no need for benefits like children’s education, health benefits, leave travel allowance, etc. than older, married employees with one or more children.

Instrumentality refers that a people would be inspired to give better performance in anticipation of promotion.

Expectancy states that the degree of chances occur to a particular activity or process or effort will lead to particular first- level results on the other hand, Instrumentality states to the degree of chances that relates first-level results and desired second-level results. In simple words, Motivation is a function of valence, instrumentality and expectancy.

Category # 3. Contemporary Theories:

The contemporary theories describe the modern concept of how people motivate at work. These include Equity and Attribution theories.

These are explained as follows:

i. Equity Theory:

J. Stacy Adams developed equity theory, and give their views that primary input on job performance and satisfaction on the basis of equity that people feel in their working conditions. Inequity comes in existence when a manpower feels that the ratio of his or her results to inputs and the ratio of a relevant other’s results to inputs are imbalanced.

Equity can be stated in two elements. One is internal and other is external. Internal equity states that the imbalance in the remuneration between the several skills or talent and responsibility level among the various manpower. Internal equity is determined through job evaluation.

External equity states that when remuneration levels for same skills levels in one organization compare with other workers in any different organization in same industry and geographical region.

External equity is determined usually through compensation surveys or interview and compensation satisfaction surveys. Companies, which pay remuneration at lower rate than the market rates, would be in problem to attract, retain and inspire manpower to perform with full efficiency.

Our manpower doesn’t perceive happiness when they get lower remuneration than what they deserve. When an employee gets remuneration at higher rates than what he/she considers is fair. Now the question is that to check out what they are receiving, what they deserve and what is fair for our manpower to maintain balance or equity in compensation system.

ii. Attribution Theory:

This theory is contributed by Fritz Heider, Lewin and Festinger. They assume that people are rational and logical in their behaviour and that both inner and outer forces get composed additively to conclude behaviour. People will behave differently if they realize that their results are controlled or supervised more internally than externally.

This theory has great efficiency for understanding organizational behaviour and contributes deep insights on goal setting, leadership behaviour and diagnosing causal factors of employee performance.

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Theories of Wages – Several Theories Propounded by Various Thinkers in the Last Centuries

Several theories of wages have been propounded by various thinkers in the last three centuries.

1. Adam Smith’s Wage Fund:

Adam Smith (1723-90) assumed that the employer was a reservoir of funds and utilized them for paying the wages of employees. If the fund was large enough, correspondingly the payment of wages was high. And if the fund was small, the wages were low. The demand for labour and the wages that could be paid were determined by the size of the fund.

2. Subsistence:

This is also known as the iron law of wages as stated by David Ricardo (1772-1823). It states that labourers should be paid to enable them to subsist without increase or diminution in their numbers. It assumes that when they were paid more than the subsistence level, they might indulge in enjoyment and consequently their numbers would increase, and this would result in a low rate of wages.

If the wages fell below the subsistence level, the number of workers would decrease as many would suffer from malnutrition and disease. Then the wage rate would increase as the number of labourers would decrease.

3. Karl Marx’s:

According to Marx, labour is an article or commodity which can be purchased on payment of a price. The price of any product is determined by the time and effort needed to produce it. The labourer is not paid in proportion to the time spent and the surplus goes to the management to meet other expenses.

4. Residual Claimant:

Francis Walker (1840-97) stated that there were four factors involved in production—land, labour, capital, and entrepreneurship. Wages represent the amount of value created in production, which remains after payments have been made for all other factors of production.

5. Marginal Productivity:

This theory was developed by Philips, Henry, and Clark. It assumes that wages depend on the demand for, and supply of, labour. Hence, labour is paid for according to its worth. As long as each worker contributes more to the total value created than his or her cost in wages, it is viable for the employer to continue, and when this becomes uneconomical, the employer may resort to other measures.

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Theories of Wages – 9 Economic Theories: Subsistence, Wage Fund, Residual Claimant, Marginal Productivity, Taussig’s, Surplus Value, Bargaining and a Few Others

Many things influence the compensation decisions made in organizations and one of them is economics. Economists view compensation as labour market determinant. Economic theories specify the economic factors that determine employee compensation.

Some of the economic theories are mentioned below:

Theory # 1. Subsistence:

This theory was originated with the Physiocratic School of the French Economists and was developed by Adam Smith and the later economists of the classical school. The German economist Lassalle called it the ‘Iron Law of Wages’ or the ‘Brazen Law of Wages’. Karl Marx made it the basis of his theory of exploitation.

According to this theory, wages tend to settle at the level just sufficient to maintain the worker and his family at the minimum subsistence level. If wages rise above the subsistence level, the workers are encouraged to marry and to have large families.

The large supply of labour brings wages down to the subsistence level. If wages fall below this level, marriages and births are discouraged and under-nourishment increases death rate. Ultimately, labour supply is decreased, until wages rise again to the subsistence level. It is supposed that the labour supply is infinitely elastic, that is, its supply would increase if the price (i.e. wage) offered rises.

Criticism:

This theory is almost completely out-dated and has no such practical application, especially in advanced countries. The theory was based on the Malthusian Theory of Population. It is inappropriate to say that every increase in wages must inevitably be followed by an increase in birth rate. An increase in wages may be followed by a higher standard of living.

(i) Ricardo was one of the exponents of the subsistence theory. He stressed the influence of custom and habit in determining what was necessary for the workers. But habits and customs change over time.

Hence, the theory cannot hold good for a longer period of time, especially of a world characterised by fast changing habits. Ricardo, therefore, admitted that wages might rise above the subsistence level for an indefinite period in an improving society.

(ii) The second criticism against this theory is that the subsistence level is more or less uniform for all working classes with certain exceptions. The theory, thus, does not explain differences of wages in different employment.

(iii) The third criticism is that the theory explains wages only with reference to supply; the demand side has been entirely ignored. On the demand side, the employer has to consider the amount of work which the employee gives him and not the subsistence of the worker.

(iv) The fourth criticism is that the theory explains the adjustment of wages over the lifetime of a generation and does not explain wage fluctuations from year to year.

(v) The fifth and the final criticism is that the term ‘subsistence’ has a very vague impression. Does it refer to the minimum requirements of a modern man or of a tribal savage?

Theory # 2. Wages Fund:

This theory was developed by Adam Smith (1723—1790) on the assumption that wages are paid out of a predetermined fund of wealth, the surplus savings of the wealthy. This fund could be utilized for employing labourers for work. If the fund was large, wages would be high; if it was small, wages would be reduced to subsistence level.

Since, the theory takes the wage fund as fixed, wages could rise only by a reduction in the number of workers. According to this theory, the efforts of trade unions to raise wages are futile. If they succeeded in raising wages in one trade, it can only be at the expense of another, since the wage fund is fixed and the trade unions have no control over population.

According to this theory, therefore, trade unions cannot raise wages for the labour class as a whole. The demand for labour and the level of wages were determined by the size of the fund.

Criticism:

This theory has been widely criticized and stands rejected now. This theory is inapplicable in highly industrialized countries, but, it is applicable in an under-developed country suffering from capital deficiency, where the wages cannot be increased unless national income is increased and capital accumulated through industrialization.

Theory # 3. Residual Claimant:

The residual claimant theory advocated by Francis Walker (1840-1897), assumes that there are four factors of production/ business activity – land, labour, capital, and entrepreneurship. According to Walker, wages are the residue left over, after the other factors of production have been paid. According to this theory, after rent, interest and profit have been paid; the remainder of the total output goes to the workers as wages.

This theory admits the possibility of increase in wages through greater efficiency of employees. In this sense, it is an optimistic theory; the subsistence theory and wages fund theory were pessimistic theories. Though this theory has been rejected by most economists on several bases.

Theory # 4. Marginal Productivity:

This theory state that, under the condition of perfect competition, every worker of same skill and efficiency in a given category will receive a wage equal to the value of the marginal product of that type of labour.

The marginal product of a labour in any industry is the amount by which the output would be increased if a unit of labour was increased, while the quantities of other factors of production remaining constant. Under perfect competition, the employer will go on employing workers until the value of the product of the last worker he employs is equal to the marginal or additional cost of employing the last worker.

Further, under perfect competition, the marginal cost of labour is always equal to the wage rate, irrespective of the number of workers the employer may engage. Since every industry is subject to diminishing returns, the marginal product of labour must start declining sooner or later. Wages remaining constant, the employer stops employing more workers at that point where the value of marginal product is just equal to the wage rate.

It is not true, as it is assumed above, that the quantities of other factors remain constant while that of labour alone increases. To allow for this, a term ‘marginal net product of labour’ has been used instead of ‘marginal product of labour’.

The value of marginal net product of labour may be defined as being the value of the amount by which output would be increased by employing one more worker with the appropriate addition of other factors of production.

Criticism:

This theory is true only under certain assumptions such as perfect competition, perfect mobility of labour, and homogenous character of all labour, constant rates of interest and rent and given prices of the product. It is a static theory. The actual world is dynamic. All assumptions are unrealistic.

The following are the criticisms against this theory:

(i) According to this theory, the labour is perfectly mobile so that they can be moved from one employment to another employment, which is not true in the real world.

(ii) According to this theory, there is unified wage rate across the market, which is impossible. Workers of the same skill and efficiency may not receive the same wages at two different places.

(iii) In case of monopsony, i.e., one buyer and many sellers, the employer has a grip on wages and can pull down the wages below the value of the marginal net product of labour. If the employees are collectively organized, the wage rates can be bargained. Therefore, the wages are not only determined by the number of workers employed but also by the relative bargaining strength of the labour union and the employer.

(iv) Another assumption of this theory is that there is an existence of perfect competitive market for products, which is also an unrealistic assumption. In the real world, the market for goods is characterised by imperfect competition.

(v) The productivity of workers is also dependent on factors such as the quality of capital and efficient management, which is outside the scope of this theory.

(vi) It should be borne in mind that the marginal net product of labour depends not merely on the supply of labour but also on the supply of all other factors of production. If other factors are plentiful and labour is relatively scarce, the marginal product of labour will be high, and vice versa.

(vii) This theory takes the supply of labour for granted. Productivity is also a function of wages. Low productivity may be the cause of low wages, which may tell on the efficiency of the worker, lower his standard of living and ultimately check the supply of labour.

Theory # 5. Taussig’s:

The American economist Taussig gives a modified version of the Marginal Productivity Theory of Wages. According to him, wages represent the marginal discounted product of labour. According to Taussig, the labourer cannot get the full amount of the marginal output.

This is because production takes time and the final product of labour cannot be obtained immediately. But the labourer has to be supported in the meantime. This is done by the capitalist employer. The employer does not pay the full amount of the expected marginal product of labour.

He deducts a certain percentage from the final output in order to compensate himself for the risk he takes in making an advance payment. This deduction, according to Taussig, is made at the current rate of interest.

Criticism:

Two weaknesses of the theory have been recognized by Taussig himself, i.e.:

(i) A dim and abstract theory remote from the problem of real life. To this he replies that this weakness is common to all economic generalizations,

(ii) The joint product is discounted at the current rate of interest, but according to his own analysis, the rate of interest is a result of the process of advance to the labourers. To meet this difficulty, Taussig suggests that we determine rate of interest independently of marginal productivity by the rate of time preference, and with the interest thus determined discount the marginal product of labour. This theory is also rejected by most economists.

Theory # 6. Demand and Supply:

Alfred Marshall, the chief exponent to this theory, explained the complexity of the economic world tried to provide a less rigid and deterministic theory. According to him, the determination of wages is affected by the whole set of actors which govern demand for and supply of labour. They demand price of labour, however, determined by the marginal productivity of the individual worker.

Just as the price of 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 Labour:

Supply of labour depends upon the following factors:

i. Size of Population- If the size of population is greater than the supply of labour will also be greater.

ii. Mobility of Labour-The supply of labour also depends upon the mobility of labour.

iii. Social Structure-Supply of labour also depends upon the social set up of a country. If any society allows the women to work, then the supply of labour will be greater.

The wages will be determined at the point where demand and supply are equal to each other.

Theory # 7. Surplus Value:

The surplus value theory of wages owes its development to Karl Marx (1818—1883). According to this theory, labour was an article of commerce, which could be purchased on the payment of the ‘subsistence price’.

The price of any product was determined by the labour and the time needed for producing it. The labourer was not paid in proportion to the time spent on work, but was paid much less, and the surplus was utilized for paying other expenses.

The capitalist was in a position to force the worker to spend more time of his job than what was necessary to earn his subsistence wage. According to Marx, the worker did not get full compensation for the time he spent on the job.

The rate of surplus value, which is the ratio of surplus labour to necessary labour, is also called the ‘rate of exploitation’ under the capitalist form of production. Marx, however, held the view that the introduction of trade union bargaining and similar interferences could stop the tendency of wages falling to their minimum level and even reverse it.

Theory # 8. Bargaining:

John Davidson, the earliest exponent of the bargaining theory of wages, argued that the wages and hours of work were ultimately determined by the relative bargaining strength of the employers and the workers.

According to this theory, there is an upper limit and a lower limit of wage rates and the actual rates between these limits are determined by the bargaining power of the employers and the workers.

The upper limit could be the highest wages that the employers would be willing to pay beyond which they will incur losses resulting from high labour costs. The lower limit could be either the minimum wages prescribed under the statute or the strength of resistance of the workers at the subsistence wages below which they will not be available for work.

Theory # 9. Purchasing Power:

The classical economists, especially Pigou argued that a cut in wages during unemployment and depression would help restoring full employment in the economy. Lord Keynes in his ‘General Theory of Employment, Interest and Money’ has criticized this classical viewpoint. Keynes looked at the problem of wage rates from a macro viewpoint.

According to him, wage is not only the cost of production to the employer but also an income for the wage earners who constitute a majority in the total working population. The same workers and their families consume a major part of the products of the industry.

Hence, if the wage rates are high they will have more purchasing power, which would increase the aggregate demand for goods and also a high level of output. Conversely, if the wage rates are low, their purchasing power would be less, which would bring about a fall in the aggregate demand.

This will have an adverse effect on the levels of employment and output. Therefore, a cut in wage rate, according to Keynes, instead of removing unemployment and depression will further add to the problem.

According to the Keynesian Theory, full employment is a function of national income; the higher the level of national income the greater the volume of employment and both income and employment are determined by effective demand. Hence, if the national income falls, it would have an adverse effect on employment.

In order to ensure incomes to wage earners and to restore full employment, Keynes recommended state intervention by adopting economic policies such as monetary and fiscal policies. The other mechanisms, according to Keynes, could be direct controls over prices, wages, investment and production.

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Theories of Wages – Theories Propounded by Famous Economists: David Ricardo, John Stuart Mill, Karl Marx, John Bates Clark, Alfred Marshall & a Few Others

The remuneration which workmen receive is termed as wages. Economists look upon wages as a payment to one of the factors of production for its contribution to the production process. The first wage theory known as the Subsistence Theory of Wages was developed by the English economist David Ricardo in 1817.

According to him, “the natural price of the labour is that price which is necessary to enable the labourers, one with another, to subsist and to perpetuate their race, without either increase or diminution”. By adopting the Malthus’ principle of population (that population tends to press upon the means of subsistence), Ricardo’s theory became an ‘iron law’ of wages. The workers were not to be paid wages above the ‘natural price’ so that there was no inducement for them to have more children.

John Stuart Mill put forth another theory in 1848. It was known as the Wage Fund Theory. Mill looked upon wages as a function of capital. According to him, out of each year’s production, a certain amount must go for equipment, raw materials and the entrepreneur’s profits, the remainder being available for labour. If more were to go to labour, then there would be less to invest. This theory was again harsh to the workers. Its assumption of a fixed stock from which wage payments were to be made was severely criticised.

Karl Marx was the first to develop a theory that asserted the workers’ rights in the industrial system. In his view, human effort was the source of all value. Other factors of production only represented the labour that was embodied in them. Employers with greater bargaining power were exploiting the workers by paying them less than the full value of their daily output. Marx apprehended more exploitation of labour by the capitalists to maintain their profits.

In the late nineteenth century, economists came up with yet another theory known as the Marginal Productivity Theory of Wages. John Bates Clark, Alfred Marshall and Prof. Hicks developed this concept. According to this theory, a private businessman in a competitive economy would employ additional labour if the added cost (marginal cost) of the labour was less than the added money returns (marginal revenue) that its hire would generate.

The workers would be free to move from lower paying industry to higher paying ones. They would continue to shift until the marginal value product of labour was the same across all industries. This would result in a uniform rate of wages in all industries for a given grade of labour. But this theory is inadequate as it fails to explain the behaviour of wages.

In practice, wage rates are fixed through a process of collective bargaining. Trade unions exert powerful influence on wage fixation. Government intervention is also there in fixing minimum wages. Economists led by Kerr and Ross believe that ‘impersonal market forces’ are no longer operative in wage determination, having been supplanted by ‘conscious human decision’. The economic theory alone cannot explain labour market and wage determination. An interdisciplinary economics is needed to arrive at a realistic and meaningful explanation of wages under collective bargaining.

The wage rate in any industry depends upon a variety of factors. The financial condition of companies and their capacity to pay; wages in other industries in the region; government policy and statutory requirements; the extent of unionisation among workers and the cost of living are important considerations in wage fixation.

In underdeveloped economies where unemployment is chronic, industrialists cannot be given the license to determine wages on the purely economic principles of demand and supply or the marginal productivity of labour. In the Standard Vacuum Refining Company of India Ltd. vs. Its Workmen (1961), the Supreme Court of India observed that “the doctrine of Laissez Faire is obsolete” and that the requirements of workmen living in a civilised and progressive society should be recognised.

The Minimum Wages Act was passed by the Government of India in 1948 on the ground of protecting labour from sweating and exploitation. The Act makes it obligatory on the part of the government to fix minimum rates of wages in employments specified in the schedule or added to it. The Act is not applied to all the industries indiscriminately. Minimum wages under the Act are recommended by the Wage Fixation Committees appointed by the government mostly in trades or part of the trades in which no arrangements exist for effective regulation of wages by collective agreements or otherwise.

In an organised industry, wages are determined industry-wise on regional or national basis through collective bargaining, compulsory adjudication, and voluntary arbitration of wage board recommendations. The wage boards are tripartite bodies meant for formulating industry-wise wage structures on a scientific basis. Separate wage boards for all major industries have been set up in India. Regional considerations do not receive much attention from the all-India boards. The cost of living and the capacity of the industry to pay are the criteria which most of the boards take seriously.

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Theories of Wages – 2 Main Theories: Economic and Behavioural Theory

The main theories of wages can be divided into two categories as follows:

1. Economic Theory:

Economic theories can be further subdivided as follows:

i. Subsistence theories – According to Ricardo (1772-1823), wages tend to settle at the level just sufficient to maintain the worker and his/her family at the minimum subsistence. The theory is no more popular.

ii. Wage fund theory – According to this theory, a fixed amount of wage fund is available for distribution at any one time and the level of wages depends on the number of labour-seeking employment. This theory also has lost its relevance because there is no justification to assume that the available fund would be constant.

iii. Marginal productivity theory – This theory mentions that any industry would go on employ­ing additional labour until the marginal productivity becomes equal to marginal cost. There is logic in this theory.

iv. Bargaining theory – John Davidson feels that there are always upper and lower limits on wages. Therefore, wages will be somewhere between these two limits depending on the bar­gaining strength of the two parties, that is, the employer and the employees.

v. Surplus value theory – Due to typical characteristic of the capitalist form of production, there is the ‘rate of exploitation’, that is, the rate of surplus value, which is the ratio of surplus labour to necessary labour. In the capital wage systems, the supply of labour is always tended to be kept in surplus, that is, in excess of the demand for it—thus the workers do not get full com­pensation for the time and labour they spend on their duty.

vi. Purchasing power theory – As per this theory, if the rates of wages are high, it will increase the purchasing power of workers which will increase the aggregate demand for goods and services which, in turn, will increase the level of output and thus the demand of labour will also go up and so will be the case with the wage rates which will further go up. Reverse will happen if the wage rates are low.

vii. Modern theories of wages – Modern theories assume that, on the one hand, wages are gov­erned by the laws of demand and supply, and, on the other hand, various external factors and constraints such as the institutions of trade unions and collective bargaining also affect the determination of wages.

2. Behavioural Theories:

The factors, other than money, such as internal and external equities, valence and contingency also affect the determination of wages.

In this regard, some of the main theories are as follows:

i. Equity theory – As per this theory, both internal and external equities should be maintained while determining wage rates, otherwise it will be difficult to attract and retain good employees.

ii. Vroom’s expectancy theory – This theory states that the motivation of employees depends on an individual’s expectations about his/her ability to perform tasks and receive the desired awards, its formula being –

Motivational force = Valence x Expectancy

iii. Herzberg’s two-factor theory – Fredrick Herzberg who propounded this theory stated that awards have got two aspects, namely – (a) hygiene factors whose absence creates dissatisfaction and (b) motivation factors which induce the employees to put in their best efforts. Hence, while determining wages, the role of the aforesaid factors should also be kept into view.

Although none of the economic and behavioural theories is perfect, all of them provide one or the other guidelines which may help in determining wage rates as appropriately as possible.

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Theories of Wages – Top 7 Theories: Subsistence, Wages Fund, Bargaining, Just Wage, Standard of Living, Residual Claimant and Contribution of Behavioural Scientists

The following theories have been produced so far as regards the wages:

(1) Subsistence Theory:

In the 18th and early 19th centuries, an English Economist Ricardo (1772-1823) developed his subsistence theory of wages. He maintained that the total amount valuable for wages was fixed and its distribution provided a subsistence wage to all the workers employed in the industry.

If real wages rise above the subsistence level, there would be increase in population to exert pressure on wages and force them to come down to the subsistence level obviously. Ricardo took his inspiration from the population theory of Malthus.

(2) Wages Fund Theory:

This theory was developed by Adam Smith (1723-1790). His basic assumption was that wages are paid out of a pre-determined fund of wealth which lies surplus, with wealthy persons as a result of savings. This fund could be utilized for employing labourers for work. If the fund was larger, wages would be high; if it was small, wages would be reduced to the subsistence level. The demand for labour and the wages that could be paid to them were determined by the size of the fund.

(3) The Bargaining Theory of Wages:

John Davidson advocated this theory. Under this theory, wages are determined by the relative bargaining power of workers or trade unions and of employers. When a trade union is involved, basic wages, fringe benefits, job differentials and individual differences tend to be determined by the relative strength of the organisation and the trade union.

(4) The Just Wage Theory:

This was the first theory on wages advocated during medieval period. The essence of this theory is that the worker should be paid on the level of maintaining himself and his family.

(5) Standard of Living Theory:

Karl Marx pointed out that the “Wage of labour is determined by traditional standard of living, which in turn is determined by the mode of production of the country concerned.”

(6) Residual Claimant Theory:

According to Walker, the wages are determined on the basis of the amount left after the payment of rent, profits and interest to land, entrepreneur and capital respectively out of the production value.

The amount of wages = Production Value – (Rent + Profits + Interest)

Contribution of Behavioural Scientists to the Wages Theory:

According to behavioural scientists, wages are determined on the basis of several factors like the size, nature, prestige of the organisation, strength of the union, social norms, traditions, customs, prestige of certain jobs in terms of authority, responsibility and status level of job, satisfaction, morale, desired lines of employee behaviour and level of performance.

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Theories of Wages – 7 Important Theories: Subsistence, Wages Fund, Surplus Value, Residual Claimant, Marginal Productivity, Bargaining & Behavioural

Wages are fixed mainly as a result of individual bargaining, collective bargaining or by public or State regulation. How wages are determined has been the subject of several theories of wages.

Theory # 1. Subsistence:

This theory, also known as “Iron Law of Wages”, was propounded by David Ricardo (1817). This theory states that- “The labourers are paid to enable them to keep alive in the race without increase or decrease”. The theory was based on the assumption that if the workers were paid more than subsistence wage, their numbers would increase as they would procreate more; and this would bring down the rate of wages.

If the wages fall below the subsistence level, the number of workers would decrease — as many would die of hunger, malnutrition, disease, cold, etc., and many would not marry, when that happened the wage rates would go up.

Theory # 2. Wages Fund:

This theory was developed by Adam Smith (1723-1790). His basic assumption was that wages are paid out of a predetermined fund of wealth which lay surplus with wealthy persons — as a result of savings. This fund could be utilised for employing labourers for work. If the funds are large, wages would be high; if it is small, wages would be reduced to the subsistence level.

Theory # 3. The Surplus Value:

This theory owes its development to Karl Marx (1818- 1883).The price of any product was determined by the labour time needed for producing it. The labourer was-not paid in proportion to the time spent on work, but much less, and the surplus went over, to be utilised for paying other expenses.

Theory # 4. Residual Claimant:

Francis A. Walker (1840-1897) propounded this theory. According to him, there were four factors of production/business activity, viz., land, labour, Capital and entrepreneurship. Wages represent the amount of value created in the production which remains after payment has been made for all these factors of production. In other words, labour is the residual (left over) claimant.

Theory # 5. Marginal Productivity:

This theory was developed by Phillips Henry Wicksteed (England) and John Bates Clark (USA). According to this theory, wages are based upon an entrepreneur’s estimate of the value that will probably be produced by the last or marginal worker. In other words, it assumes that wages depend upon the demand for, and supply of, labour.

Consequently, workers are paid what they are economically worth. The result is that the employer has a larger share in profit as he has not to pay to the non-marginal workers. As long as each additional worker contributes more to the total value than the cost in wages, it pays the employer to continue hiring; where this becomes uneconomic, the employer may resort to superior technology.

Theory # 6. Bargaining:

John Davidson propounded this theory. Under this theory, wages are determined by the relative bargaining power of workers or trade unions and of employers. When a trade union is involved, basic wages, fringe benefits, job differentials and individual differences tend to be determined by the relative strength of the organisation and the trade union.

Theory # 7. Behavioural:

Many behavioural scientists — notably industrial psychologists and sociologists — like Marsh and Simon, Robert Dubin, Eliot Jacques have presented their views of wages and salaries, on the basis of research studies and action programmes conducted by them.

Such theories are:

i. The Employee’s Acceptance of a Wage Level:

This type of thinking takes into consideration the factors which may induce an employee to stay on with the company. The size and prestige of the company, the power of the union, the wages and benefits that the employee receives in proportion to the contribution made by him — all have their impact.

ii. The Internal Wage Structure:

Social norms, traditions, customs prevalent in the organisation and psychological pressures on the management, the prestige attached to certain jobs in terms of social status, the need to maintain internal consistency in wages at the higher levels, the ratio of the maximum and minimum wage differentials, and the norms of span of control, and demand for specialized labour all affect the internal wage structure of an organisation.

iii. Wage and Salaries and Motivators:

Money often is looked upon as means of fulfilling the most basic needs of man. Food, clothing, shelter, transportation, insurance, pension plans, education and other physical maintenance and security factors are made available through the purchasing power provided by monetary income — wages and salaries.

Merit increases, bonuses based on performance, and other forms of monetary recognition for achievement are genuine motivators. However, basic pay, cost of living increases, and other wage increases unrelated to an individual’s own productivity typically may fall into maintenance category.

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