wage theories - compensation management - manu melwin joy

Wage theoriesCompensation Management

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Manu Melwin JoyAssistant Professor

Ilahia School of Management Studies

Kerala, India.Phone – 9744551114

Mail – [email protected]

Market theories – Wage theoriesCompensation Management

Market theories• Classical economists

argue that wages—the price of labor—are determined (like all prices) by supply and demand. They call this the market theory of wage determination.

Market theories

• When workers sell their

labor, the price they can

charge is influenced by

several factors on the

supply side and several

factors on the demand

side.

Market theories• The most basic of these

is the number of workers available (supply) and the number of workers needed (demand). In addition, wage levels are shaped by the skill sets workers bring and employers need, as well as the location of the jobs being offered.

Market theories• The interplay between all of

these factors will eventually cause wages to settle—that is, the number of workers, the number of jobs, the skills involved, and the location of the jobs will eventually lead workers and employers to reach a series of wage agreements.

Market theories• If employers (demand) cannot

find enough workers to meet their needs, they will keep raising their wage offers until more workers are attracted. If workers are in abundance (supply), wages will fall until the surplus labor decides to go elsewhere in search of jobs. When supply and demand meet, the equilibrium wage rate is established.

Human Capital theories – Wage theoriesCompensation Management

Human Capital theories• A particular application of

marginalist analysis (a refinement of marginal-productivity theory) became known as human-capital theory. It has since become a dominant means of understanding how wages are determined.

Human Capital theories• It holds that earnings in

the labour market depend upon the employees’ information and skills. The idea that workers embody information and skills that contribute to the production process goes back at least to Adam Smith.

Human Capital theories• It builds on the recognition

that families make a major contribution to the acquisition of skills. Quantitative research during the 1950s and ’60s revealed that aggregate growth in output had outpaced aggregate growth in the standard inputs of land, labour, and capital.

Human Capital theories• Economists who explored this

phenomenon suggested that

growth in aggregate

knowledge and skills in the

workforce, especially those

conveyed in formal education,

might account for this

discrepancy.

Human Capital theories• In the early 1960s the

American economist Theodore

W. Schultz coined the term

human capital to refer to this

stock of productive knowledge

and skills possessed by

workers.

Bargaining theories – Wage theoriesCompensation Management

Bargaining theories• John Davidson

propounded this theory.

Under this theory, wages

are determined by the

relative bargaining power

of workers of their union

and of employers.

Bargaining theories• The bargaining theory of

wages holds that wages,

hours, and working

conditions are determined

by the relative bargaining

strength of the parties to

the agreement.

Bargaining theories• Smith hinted at such a

theory when he noted that employers had greater bargaining strength than employees. Employers were in a better position to unify their opposition to employee demands, and employers were also able to withstand.

Bargaining theories• Limitations on the scope of

bargaining are also suggested by theory. Collective bargaining can be seen as the reduction of two risks to which the worker is exposed through individual bargaining.

Bargaining theories• here is first the risk that

the worker will be merely one of a number of applicants for a single vacancy and that competition between them will force the pay down.

Bargaining theories• In the bargaining theory of

wages, there is no single economic principle or force governing wages. Instead, wages and other working conditions are determined by workers, employers, and unions, who determine these conditions by negotiation.

Behavioral theory – Wage theoriesCompensation Management

Behavioral theories• Many behavioural scientists

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

Behavioral theories• It has been found that wages

are determined by such factors

as . size and prestige of the

company, strength of the

union, the employer’s concern

to maintain the workers,

contribution by different kinds

of workers, etc.

Behavioral theories• Wage differentials are

explained by social norms, traditions, customers prevalent in the organisation psychological pressures on the management, prestige attached to certain jobs in terms of social status, need to maintain internal consistency in wages at the higher levels, the wages paid for similar jobs in other firms, etc.

Subsistence theory – Wage TheoriesCompensation Management

Subsistence theory• This theory propounded by

the economists in the 18th century was later explained by David Ricardo.

• This theory is based on two assumptions, namely,– (a) The law of diminishing

return applies to industry.– (b) There is a rapid

increase in population.

Subsistence theory

• The subsistence theory

laid down that ‘the

workers are paid to

enable them to subsist

and perpetuate the race

without increase or

diminution’.

Subsistence theory

• 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.

Subsistence theory

• 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 rate would go up.

Subsistence theory• The subsistence theory is criticized on

the following grounds: – (a) The subsistence theory does not

take into consideration the demand for labour. It considers only the supply of labour and the cost of production.

– (b) This theory is based on theory of population which is itself defective. It is wrong to say that population will increase if the economic condition of the labour is improved. These days, better economic condition is associated with lower birth rate.

Subsistence theory• The subsistence theory is criticized on

the following grounds: – c) In developed countries, workers

are not merely contented with fulfillment of basic needs. They also require luxuries of life to raise their standard of living.

– (d) This theory does not emphasis the efficiency of the workers.

– (e) This theory fails to explain the wage differentials in different regions and among different categories of workers.

Wage Fund theory – Wage TheoriesCompensation Management

Wage Fund theory

• This theory was

developed by Adam

Smith and was further

expounded by J.S.Mill.

Wage Fund theory

• J.S. Mill said that wages

mainly depend upon

demand for and supply

of labour or the

proportion between

population and capital

available.

Wage Fund theory

• The amount of Wages Fund

is fixed. Wages can’t be

increased without

decreasing the number of

workers and vice versa. It is

the Wages Fund which

determines the demand for

labour.

Wage Fund theory

• However, the supply of

labour can’t be changed at a

given time. But if the supply

of labour increases along

with increase in population,

the average wages will go

down.

Wage Fund theory

• Therefore in order to

increase the average wages,

firstly, the Wages Fund

should be enlarged,

secondly, the number of

workers asking tor

employment should be

reduced.

Wage Fund theory

• This theory is criticized on

the following grounds:

– (a) This theory does not

explain differences in wages at

different levels and in

different regions.

– (b) It is not clear from where

the Wages Fund will come.

Wage Fund theory

• This theory is criticized on

the following grounds: – (c) No emphasis has been

given to the efficiency of workers and productive capacity of firms.

– (d) This theory is unscientific as Wages Fund is created first and wages are determined later on. But in practice, the reverse is true.

Surplus Value theory – Wage TheoriesCompensation Management

Surplus Value theory

• Karl Marx accepted Ricardo’s

labour theory of value , but

he subscribed to a

subsistence theory of wages

for a different reason than

that given by the classical

economists.


• In Marx’s estimation, it was

not the pressure of

population that drove wages

to the subsistence level but

rather the existence of large

numbers 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 labour

necessary to create it.


• Furthermore, Marx held

that, in capitalism, labour

was merely a commodity: in

exchange for work, a

labourer would receive a

subsistence wage.

Surplus Value theory• 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 labour theory of value

and the subsistence theory

of wages were also found to

be invalid. Without them,

the surplus-value theory

collapsed.

Residual Claimant Theory– Wage TheoriesCompensation Management

Residual Claimant Theory

• It was Francis A. Walker who

propounded this theory.

According to him, there were

four factors of production,

viz., land, labour, capital and

entrepreneurship.


• The residual-claimant theory

holds that, after all other

factors of production have

received compensation for

their contribution to the

process, the amount of

capital left over will go to the

remaining factor.

Residual Claimant Theory• In 1875 Walker worked out a

residual theory of wages in which

the shares of the landlord, capital

owner, and entrepreneur were

determined independently and

subtracted, thus leaving the

remainder for labour in the form

of wages.


• 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 claimant. The wages

are equal to the whole

production minus rent,

interest, and profit.


• It should be noted, however,

that any of the factors of

production may be selected

as the residual claimant—

assuming that independent

determinations may be

made for the shares of the

other factors.


• It is doubtful, therefore,

that such a theory has

much value as an

explanation of wage

phenomena.

Marginal Productivity Theory– Wage TheoriesCompensation Management

Marginal Productivity Theory

• 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

workers.


• 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 employers

has larger share in profit as

has not to pay to the non-

marginal workers.

Marginal Productivity Theory• This theory is criticized on

the following grounds: – (a) It is wrong to assume

that more labour could be used without increasing the supply of production facilities.

– (b) This theory is based on perfect competition in the market which is seldom found in practice.

Marginal Productivity Theory• This theory is criticized on

the following grounds: – (c) In practice, the

employers offer wages less than the marginal productivity of labour. In many cases, the labour unions are able to bargain for wages higher than the marginal productivity of labour.

Purchasing Power Theory– Wage TheoriesCompensation Management

Purchasing Power Theory

• The purchasing-power

theory of wages concerns

the relation between wages

and employment and the

business cycle.


• It is not a theory of wage

determination but rather a

theory of the influence

spending has (through

consumption and

investment) on economic

activity.


• The theory gained

prominence during the Great

Depression of the 1930s,

when it became apparent

that lowering wages might

not increase employment as

previously had been

assumed.


• The theory is based on the

assumption that changes in

wages will have a significant

effect on consumption

because wages make up

such a large percentage of

the national income.


• It is therefore assumed that

a decline in wages will

reduce consumption and

that this in turn will reduce

demand for goods and

services, causing the

demand for labour to fall.

Purchasing Power Theory• If wages fall more rapidly

than prices, labour’s real wages will be drastically reduced, consumption will fall, and unemployment will rise—unless total spending is maintained by increased investment, usually in the form of government spending.

Purchasing Power Theory• Conversely, if wages fall less

rapidly than prices, labour’s real wages will increase, and consumption may rise. If investment is at least maintained, total spending in terms of constant dollars will increase, thus improving employment.


• It should be noted that the

purchasing-power theory

involves psychological and

other subjective

considerations as well as

those that may be measured

more objectively.

wage theories - compensation management - manu melwin joy

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