Iron law of wages

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The Iron Law of Wages is a proposed law of economics that asserts that real wages always tend, in the long run, toward the minimum wage necessary to sustain the life of the worker. The theory was first named by Ferdinand Lassalle in the mid-nineteenth century. Karl Marx and Friedrich Engels attribute the doctrine to Lassalle (notably in Marx's 1875 Critique of the Gotha Programme), the idea to Thomas Malthus's An Essay on the Principle of Population, and the terminology to Goethe's "great, eternal iron laws" in Das Göttliche.[1][2][3]

Lassalle[edit]

According to Alexander Gray,[4] Ferdinand Lassalle "gets the credit of having invented" the phrase the "iron law of wages", as Lassalle wrote about "das eiserne und grausame Gesetz" (the iron and cruel law).[5]

According to Lassalle, wages cannot fall below subsistence wage level because without subsistence, laborers will be unable to work. However, competition among laborers for employment will drive wages down to this minimal level. This follows from Malthus' demographic theory, according to which population increases when wages are above the "subsistence wage" and falls when wages are below subsistence. Assuming the demand for labor to be a given monotonically decreasing function of the real wage rate, the theory then predicted that, in the long-run equilibrium of the system, labor supply (i.e. population) will be equated to the numbers demanded at the subsistence wage.

The justification for this was that when wages are higher, the supply of labor will increase relative to demand, creating an excess supply and thus depressing market real wages; when wages are lower, labor supply will fall, increasing market real wages. This would create a dynamic convergence towards a subsistence-wage equilibrium with constant population.

As David Ricardo noticed, this prediction would not come true as long as a new investment, technology, or some other factor caused the demand for labor to increase faster than population: in that case, both real wages and population would increase over time. The demographic transition (a transition from high birth and death rates to low birth and death rates as a country industrializes) changed this dynamic in most of the developed world, leading to wages much higher than the subsistence wage. Even in countries which still have rapidly expanding populations, the need for skilled labor causes some wages to rise much faster than others.

To solve the question for why wages often tend towards subsistence, Ricardo put forth the Law of Rent. Ricardo and Malthus debated this in a lengthy personal correspondence. [6]

Ricardo[edit]

The content of the iron law of wages has been attributed to economists writing earlier than Lassalle. For example, Antonella Stirati[7] notes that Joseph Schumpeter claimed that Anne-Robert-Jacques Turgot first formulated the concept. Some (e.g., John Kenneth Galbraith[8]) attribute the idea to David Ricardo, who supposedly justified it on the basis of Malthus's theory of population. According to Terry Peach,[9] economists interpreting Ricardo as having a more flexible view of wages include Haney (1924), J. R. Hicks (1973), Frank Knight (1935), Ramsay (1836), George Stigler (1952), and Paul Samuelson (1979).

Antonella Stirati disputes the attribution of the law's idea to Classical economists other than Malthus. She sees Ricardo, for example, as being closer to the more flexible views of population characteristic of economists prior to Malthus.[10] Ricardo drew a distinction between a natural price and a market price. For Ricardo, the natural price of labor was the cost of maintaining the laborer. However, Ricardo believed that the market price of labor or the actual wages paid could exceed subsistence level indefinitely due to countervailing economic tendencies:

Notwithstanding the tendency of wages to conform to their natural rate, their market rate may, in an improving society, for an indefinite period, be constantly above it; for no sooner may the impulse, which an increased capital gives to a new demand for labor, be obeyed, than another increase of capital may produce the same effect; and thus, if the increase of capital be gradual and constant, the demand for labor may give a continued stimulus to an increase of people...[11]

Furthermore, Ricardo not only believed that the market price of labor could long exceed the subsistence or natural wage but also claimed that the natural wage was not what was needed to physically sustain the laborer but depended on "habits and customs":

It is not to be understood that the natural price of labor, estimated even in food and necessaries, is absolutely fixed and constant. It varies at different times in the same country, and very materially differs in different countries. It essentially depends on the habits and customs of the people. An English laborer would consider his wages under their natural rate, and too scanty to support a family, if they enabled him to purchase no other food than potatoes, and to live in no better habitation than a mud cabin; yet these moderate demands of nature are often deemed sufficient in countries where 'man's life is cheap', and his wants easily satisfied. Many of the conveniences now enjoyed in an English cottage, would have been thought luxuries in an earlier period of our history.[11]

Criticism[edit]

Mainstream criticism[edit]

Many modern economists believe firms pay their workers a premium over subsistence levels to make them more efficient. In the theory of efficiency wages, firms pay above market clearing wages so that there is some level of unemployment, which discourages workers from shirking or switching firms.

Such an explanation does not take into consideration the Law of Supply and Demand. Workers enter and stay in a field because of the wages offered. Booming industries offer higher wages, forcing other industries to pay more in order to keep workers, so long as the supply of workers does not exceed the demand.

The fact that workers can also strike out on their own and compete with their employers requires wages to be high enough to dissuade workers from doing so. The iron law is inapplicable where employees are free, capital can be borrowed to recreate the technology involved, customers are free to switch suppliers, and employers don't have enough economies of scale to make it prohibitively difficult for employees to compete with their employers on their own.[citation needed]

Socialist criticism[edit]

Socialist critics of Lassalle and of the alleged iron law of wages, such as Karl Marx, argued that although there was a tendency for wages to fall to subsistence levels, there were also tendencies which worked in opposing directions.[12] Marx criticized the Malthusian basis for the iron law of wages. According to Malthus, humanity is largely destined to live in poverty because an increase in productive capacity results in an increase in population. Marx criticized Lassalle for misunderstanding David Ricardo. Marx also noted that the foundation of what he called "modern political economy" only needs, for the theory of value, that wages be a given magnitude. He did this in praising the Physiocrats.[13]

References[edit]

  1. ^ Critique of the Gotha Programme, Karl Marx, Chapter 2, footnote 1, (1875)
  2. ^ "Letters: Marx-Engels Correspondence 1875". Marxists.org. Retrieved 2010-10-13. 
  3. ^ http://www.jstor.org/pss/1816859
  4. ^ Gray, Alexander (1946, 1947) The Socialist Tradition: Moses to Lenin, Longmans, Green and Co., p. 336
  5. ^ Lassalle, Ferdinand (1863) Offenes Antwortschreiben, http://www.marxists.org/deutsch/referenz/lassalle/1863/03/antwortschreiben.htm
  6. ^ David Ricardo, The Works and Correspondence of David Ricardo, ed. Piero Sraffa with the Collaboration of M.H. Dobb (Indianapolis: Liberty Fund, 2005), 11 vols. http://oll.libertyfund.org/title/159
  7. ^ Stirati, Antonella (1994). The Theory of Wages in Classical Economics: A study of Adam Smith, David Ricardo and Their Contemporaries. Aldershot: Edward Elgar. p. 43. ISBN 1-85278-710-4. 
  8. ^ Galbraith, John Kenneth (1987). Economics in Perspective: A Critical History. Boston: Houghton Mifflin. p. 84. ISBN 0-395-35572-9. 
  9. ^ Peach, Terry (1993). Interpreting Ricardo. New York: Cambridge University Press. pp. 9–10. ISBN 0-521-26086-8. 
  10. ^ Stirati, Antonella (1994). The Theory of Wages in Classical Economics: A study of Adam Smith, David Ricardo and Their Contemporaries. Aldershot: Edward Elgar. p. 120. ISBN 1-85278-710-4. 
  11. ^ a b Ricardo, David. "On the Principles of Political Economy and Taxation chapter 5, On Wages". Library of Economics and Liberty. Retrieved 2006-07-21. 
  12. ^ Marx, Karl (1965) Capital, Volume 1, Chapter XXV: "The General Law of Capitalist Accumulation", Progress Publishers
  13. ^ Marx, Karl (1963, 1969) Theories of Surplus Value, Part I, Chapter II, Progress Publishers