COMPENSATION
LESSON 8:
INTRODUCTION TO THE THEORY
OF WAGES
Learning Objectives (v) Any other amenity or service excluded from the
MANAGEMENT
• To further understand the concept of wages computation of wages by a general or special order of an
appropriate governmental authority.
• To understand different Theory of wages
A wage level is an average of the rates paid for the jobs of an
• To know the relation between Labour and Wages
organization, an establishment, a labour market, an industry, a
Wages region or a nation. A wage structure is a hierarchy of jobs to
Wages in the widest sense mean any economic compensation which wage rates have been attached.
paid by the employer under some contrast to his workers for
Labor and Wages
the services rendered by them. Wages, therefore, include family
The type of job one does and the financial compensation he or
allowance, relief pay, financial support and other benefits.
she receives are very important in our society. Job type is linked
But, in the narrower Sense wages are the price paid for the to status as is wealth. While the type of job one performs is
services of labor in the process of production and include only arguably more important status wise then wealth, both are
the performance wages or wages proper. They are composed of important to Americans.
two parts - the basic wage and other allowances.
In the past we used to use other descriptions to classify
The basic wage is the remuneration, by way of basic salary and workers. The terms blue collar or white collar employees were
allowances, which is paid or payable to an employee in terms of used to describe the type of vocation.
his contract of employment for the work done by him.
Blue Collar - Manual laborers
Allowances, on the other hand, are paid in addition to the basic
wage to maintain the value of basic wages over a period of White Collar - Officer workers
time. Pink Collar - Jobs associated with women like nursing,
Such allowances include holiday pay, overtime pay, bonus and secretarial, etc. This being a rather sexist term, is no longer used.
social security benefits. These are usually not included in the Today we classify our work roles into three categories called
definition of wages. labor grades. The se labor grades are described below:
However, in India, different Acts include different items under Skilled Labor
wages, though all the Acts include basic wage and dearness These are workers who have received specialized training to do
allow come under the term wages. For example, under the their jobs. They have developed and honed a special skill and
Workmen’s Compensation Act, 1923, Section 2 (m), “wages for may or may not need to be licensed of certified by the state.
leave period, holiday pay, overtime pay, bonus, attendance Some examples of skilled labor are: carpenters, plumbers,
bonus, and good conduct bonus” form part of wages. electricians, business executives and managers, artisans,
Under the payment of wages act, 1936 section 2 (VI) “any accountants, engineers, police, mechanics, etc. These may be blue
award of settlement and production bonus, if paid, constitutes or white collar workers.
wages.” Unskilled Labor
But under the Payment of Wages Act, 1948, “retrenchment These are workers who have received no special training and
compensation, payment in lieu of notice and gratuity payable have few specific skills. As our society has grown into an
on discharge constitute wages.” increasingly technological one, the members of this group have
The following type of remuneration, if paid, do not amount to developed more and more skills. A mechanic, for example, used
wages under any of the Acts: to be considered unskilled labor.
(i) Bonus or other payments under a profit-sharing scheme Today that is no longer the case. Mechanics require a great deal
which do not form a part of the contract of employment. of skill and training to work with today’s modern engines.
(ii)Value of any house accommodation, supply of light, water, Examples of unskilled laborers are construction workers,
medical attendance, traveling allowance; or -payment in lieu sanitation and custodial workers, painters, factory assembly line
thereof or any other concession. workers, etc. These are blue collar workers.
(iii) Any sum paid to defray special expenses entailed by the Professionals
nature of the employment of a workman. Arguably the elite of the labor grades, these are those workers
who need an advanced degree to do their jobs. The three
(iv) Any contribution to pension, provident fund, or a scheme
primary groups of professional are doctors, lawyers and
of social security and social insurance benefits.
teachers. These are white collar workers.
© Copy Right: Rai University
3 4 11.324
COMPENSATION
These labor grades are often said to be non competing labor If the wages fall below the subsistence level, the number of
grades because workers rarely move from one grade to another workers would decrease - as many would die of hunger,
and do not compete salary wise with each other. There are malnutrition, disease, cold, etc. and many would not marry,
reasons why they do not compete with each other. when that happened the wage rates would go up.
The cost of education and training may be a significant obstacle. In economics, the subsistence theory of wages states that wages
They might lack the opportunity to make such a move and they in the long run will tend to the minimum value needed to keep
might also have a lack of initiative. workers alive. The justification for the theory is that when wages
MANAGEMENT
are higher, more workers will be produced, and when wages are
Theory of wages
lower, some workers will die, in each case bringing supply back
There are two key theories that explain why salaries are the way
to a subistence-level equilibrium.
they are in a particular field. These two theories are:
The subsistence theory of wages is generally attributed to David
1.Traditional Theory of Wage Determination
Ricardo, and plays a large role in Marxist economics. Most
In this theory the law of supply and demand dictates salary.
modern economists dismiss the theory, arguing instead that
These days programmers are in short supply and are in great
wages in a market economy are determined by marginal
demand thus they will command a higher salary.
productivity
Likewise doctors and lawyers whose specialized skills people
2. Wages fund Theory
need command a high wage. If you looked at the bill my
This theory was developed by Adam Smith (1723-1790). His
electrician gave me you would know he is in demand!
basic assumption was that wages are paid out of a pre-
2.Theory of Negotiated Wages determined fund of wealth which lay surplus with wealthy
Those employees who work in unions where the union persons - as a result of savings.
negotiates salary on behalf of all workers fit into this theory.
This fund could be utilized for employing laborers for work. If
Since I am a teacher my salary is set by collective bargaining with
the fund was large, wages would be high; if it was small, wages
my union. I may be the best teacher in the world sought after
would be reduced to the subsistence level. The demand for
by many students and parents but it wouldn’t matter.
labour and the wages that could be paid them were determined
However, different methods of wage payment are prevalent in by the size of the fund.
different industries and in various countries. There may be
3.The Surplus value theory of Wages
payment by time or payment by results, including payment at
This theory owes its development to Karl Marx (1818-1883).
piece rates.
According to this theory, the labour was an article of commerce,
Wages are fixed mainly as a result of individual bargaining, which could be purchased on payment of ‘subsistence. price.’
collective bargaining or by public or State regulation. How wages
The price of any product was determined by the labour time
are determined has been the subject of several theories of
needed for producing it. The labourer was not paid in
wages. The main elements in these theories may be summed up
proportion to the time spent on work, but much less, and the
as follows:
surplus went over, to be utilized for paying other expenses.
Below is mentioned the theory of Wages:
Marx himself considered his theory of surplus-value his most
(1) Subsistence theory important contribution to the progress of economic analysis
(2) Wages fund theory (Marx, letter to Engels of 24 August 1867).
(3) The surplus value theory of wages It is through this theory that the wide scope of his sociological
(4) Residual claimant theory and historical thought enables him simultaneously to place the
capitalist mode of production in his historical context, and to
(5) Marginal productivity theory
find the root of its inner economic contradictions and its laws
(6) The bargaining theory of wages of motion in the specific relations of production on which it is
(7) Behavioural theories based.
Now let us discuss the theory of Wages in detail: 4.Residual claimant Theory
(1) Subsistence theory Francis A. Walker (1840-1897) propounded this theory.
This theory, also known as ‘Iron Law of Wages,” was According to him, there were four factors of production/
propounded by David Ricardo (1772-1823). This theory (1817) business activity, viz., land, labour, capital and entrepreneurship.
states that: “The laborers are paid to enable them to subsist and Wages represent the amount of value created in the production,
perpetuate the race without increase or diminution.” which remains after payment has been made for all these factors
The theory was based on the assumption that if the workers of production. In other words, labour is the residual claimant.
were paid more than subsistence wage, their numbers would 5.Marginal productivity Theory
increase as they would procreate more; and this would bring This theory was developed by Phillips Henry Wicksteed
down the rate of wages. (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
© Copy Right: Rai University
11.324 3 5
COMPENSATION
worker. In other words, it assumes that wages depend upon Case Study
the demand for, and supply of, labour.
Breaking The Bargaining Pattern
Consequently, workers are paid what they are economically Gilson steel is a local fabricating and supply firm. Situated in
worth. The result is that the employer has a larger share in profit open country, far from the large steel making centers. The firm
as has not to pay to the non-marginal workers. As long as each has been in business many years.
additional worker contributes more to the total value than the
About the third of employees have worked in the organization
cost in wages, it pays the employer to continue hiring; where
for more than ten years.Top management would like to get
MANAGEMENT
this becomes uneconomic, the employer may resort to superior
away from the current practice in which negotiations on wage
technology.
matters and fringes follow the pattern.
6.The bargaining theory of wages The firms president feels that industry – wide bargaining tends
John Davidson propounded this theory. Under this theory, to divorce employees from the firm . He thinks they feel that
wages are determined by the relative bargaining power of their employer is a combination of U.S steel and bethlem
workers or trade unions and of employers. When a trade union steel instead of Gilson . he argues that the local firm which
is involved, basic wages, fringe benefits, job differentials and has prospered , can do better by employees than is possible
individual differences tend to be determined by the relative in national pattern . he says that the local conditions should
strength of the organization and the trade union. be taken into account . his basic objection to current practice ,
7.Behavioural theories however , is his conviction that it tends to divorce its
Many behavioral scientists - notably industrial psychologists and employees from local employer. The labour relations manager
sociologists like Marsh and Simon, Robert Dubin, Eliot Jacques has been urged to try negotiating terms at variance with the
have presented their views or wages and salaries, on the basis of national pattern .
research studies and action programmes conducted by them. Answer the following questions:
Briefly such theories are:
• What theory and policy do you read into the presidents
The Employee’s Acceptance of a Wage Level suggestion?
This type of thinking takes into consideration the factors, which • How will his ideas fit into the existing pattern of public
may induce an employee to stay on with a company. The size union policy?
and prestige of the company, the power of the union, the
• Can you suggest a promising innovative approach
wages and benefits that the employee receives in proportion to
the contribution made by him - all have their impact.
The Internal Wage Structure
Social norms, traditions, customs prevalent in the organization
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 organization.
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.
Assignments
1. Explain the importance of the theory of wages.
2. State the difference between blue collar, white collar and pink-
collar employees.
3. What are the different types of theory of wages? Explain in
detail.
© Copy Right: Rai University
3 6 11.324
