The Theory of Wages

The theory of the determination of wages in a free market is simply a special case of the general theory of value. Wages are the price of labour; and thus, in the absence of control, they are determined, like all prices, by supply and demand. The need for a special theory of wages only arises because both the supply of labour, and the demand for it, and the way in which demand and supply interact on the labour market, have certain peculiar properties, which make it impossible to apply to labour the ordinary theory of commodity value without some further consideration.

When the marginal productivity theory is stated in the form which has been adopted in the preceding chapter, it seems to be free from most of the objections which have been brought against it by its critics. Taken as a condition of full equilibrium in the labour market, it is immune from the criticism so often made against it — that the existence of fixed plant makes the free variation of the proportions in which factors of production are employed impossible. Once we realise that fixed plant has to be replaced, and that if the relative prices of the factors have changed, it is likely to be replaced in a different form, this objection collapses; leaving behind it, however, the important conclusion that the full effects of a change in wages on the demand for labour must not be expected to reveal themselves at once.

On the threshold of a more extended study of the competitive labour market must stand the problem of unemployment. What is the effect of unemployment on wages? How is it possible to reconcile the fact of unemployment with the simultaneous existence of rising wages? These are not the only new questions raised by the fact that the labour market of actuality is not in a state of equilibrium; but they are the most obvious questions, and we may conveniently begin by examining them.

It has become clear that the effect of unemployment on wages can only be explained if we allow very fully for two general circumstances which do not receive much attention in equilibrium theory—the time and trouble required in making economic adjustments, and the fact of foresight. Even in equilibrium theory the importance of these things is not quite negligible; but their significance is immensely enhanced when we come to deal with “economic dynamics” —the theory of change. It is by considering them that dynamic analysis can best begin, to whatever part of the economic field that dynamic analysis is to be applied. Naturally they are the most convenient means of approach to the dynamic enquiry which is necessary to complement an equilibrium theory of wages.

When an employer hires a workman, he buys work. The wage he is prepared to pay—the price he is prepared to give—depends on the amount of work—the amount of the commodity bought—he expects to receive in return. Other things being equal, a more efficient workman offers more “work” than a less efficient; and he receives higher wages in consequence. In our earlier discussions, we have assumed these other things to be equal, so that the amount of work offered by each man is something fixed, depending on the nature of that man, but not on the conditions on which he is employed. It is now time to drop this convenient simplification. The amount of work a man does is partly a matter of choice, and the amount he chooses to do depends on what he gets for it; if he works under superintendence, the conditions of this superintendence also affect the amount of work he does; and further, his ability to work may be affected by the wages he has been in the habit of receiving in the past.

The subject of this chapter is one of the most venerable of economic problems. The effect of progress upon distribution was a question inevitably raised by the Ricardian theory of rent, and naturally it often engaged the attention of the classical economists. But we do not now need to go back to the classical economists; for we possess today, in the marginal productivity theory, a much superior line of approach to it. The marginal productivity theory is simply an extension of the Ricardian law of rent; and it suggests the problem as infallibly as its predecessor did.

It is now time for us to take a further step towards actuality. The equilibrium labour market, which we studied in the first chapters of this book, could never exist; it is merely a convenient abstraction, by which we can isolate for thorough examination some, but only some, of the fundamental factors at work. The free labour market, which we studied in Chapters III.-V., is, on the other hand, a real possibility; markets very similar in their working to this have existed and do exist. Yet it is hardly possible for a market to exist, as we have been supposing, in a condition of violent change, without competition being displaced to some extent by combination. The combination may be abortive, in which case the account already given is reasonably complete, apart from some rearrangement of motives; but if it is not abortive (and in advanced communities it is unusual for it to be so altogether) we have yet some significant strokes to add to our picture.

Since the publication of Mr. and Mrs. Webb’s great history in 1894, much has been written on the development of the English Trade Unions. But it is the social and political aspects of this evolution which have been most thoroughly examined; the economic aspects have been much less adequately treated. The economist, seeking an answer to the most fundamental economic problems of Union development, can get little help from the historical literature, and is largely left to his own devices. To him the most important question is not any of those which have been so exhaustively studied, but rather the determination of the extent to which, at different periods, the Trade Unions have been able to affect wages. And to this economic historians, with their eyes fixed on the qualitative rather than quantitative differences between competitive and collective wage-fixing, have rarely attempted to give an answer.

It is now time to return from this historical digression to the general issues of theory with which we are more directly concerned. We have examined the conditions which make it possible for Trade Unions to secure at any time the payment of wages higher than would have been paid in a competitive market. We may now assume that such wages are being paid, whether as the result of Trade Union pressure or because they have simply been imposed by the State; and we may proceed to enquire what the consequences of such a situation are likely to be.

How far can we expect the process of contraction described in the last chapter to lead to the establishment of a new equilibrium? This is the first question which we must endeavour to solve with the aid of our analysis of Distribution and Economic Progress. (It is true that we are now concerned with a process of decline, rather than one of progress; but, within limits, our earlier analysis was equally applicable to either case.)