Subsistence theory of wages

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The Subsistence Theory of Wages, also known as the "Iron Law of Wages," was an alleged law of economics that asserted that real wages in the long run would tend to the value needed to keep the workers' population constant. The alleged law was named and popularized by the German socialist Ferdinand Lassalle in the mid 1800s.

According to Lassalle, wages cannot fall below subsistence level because without subsistence, labourers will be unable to work for long. However, competition among labourers for employment will drive wages down to this minimal level. This followed from Malthus' demographic theory, according to which the growth rate of population was – mainly for cultural reasons – an increasing function of wages, reaching a zero for a unique positive value of the real wages rate, called the subsistence wage. Assuming the demand for labour to be a given monotonically decreasing function of the real wages rate, the theory then predicted that, in the long-run equilibrium of the system, labour 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 labour will increase relative to demand, creating an excess supply and thus depressing market real wages; while when wages are lower, labour supply will fall, increasing market real wages. This would create a dynamic convergence towards a subsistence-wage equilibrium with constant population.

As David Ricardo first noticed, this prediction would not come true as long as a new investment or some other factor caused the demand for labour to increase at least as fast as population: in that case the equality between labour demanded and supplied could in fact be kept with real wages higher than the subsistence level, and hence an increasing population. In most of his analysis, however, Ricardo kept Malthus' theory as a simplifying assumption.

During the mid-1800s, when Lassalle articulated his theory, wages for both manufacturing labourers and agricultural workers were in large part quite close to subsistence level.

Contents 1 Ricardo 2 Criticism of the Iron Law of Wages 2.1 Mainstream criticism 2.2 Socialist criticism 2.3 Austrian criticism 3 References

[edit] Ricardo

The subsistence theory of wages has been frequently attributed to the English economist David Ricardo. However, this attribution is disputed. Ricardo drew a distinction between a natural price and a market price. For Ricardo, the natural price of labour was the cost of maintaining the labourer. However, Ricardo believed that the market price of labour 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 labour, 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 labour may give a continued stimulus to an increase of people...."^[1]

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

"It is not to be understood that the natural price of labour, 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 labourer 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."^[1]

[edit] Criticism of the Iron Law of Wages

[edit] Mainstream criticism

In modern times, the predictions of Lassalles' subsistence theory of wages have been discredited not only by continuing economic growth – along the lines already known to Ricardo – but also by the demographic transition whereby in richer societies demographic growth becomes a falling function of real incomes and wages, upturning Malthus' demographic theory. Thus, mainstream economics rejects the subsistence theory of wages.

[edit] Socialist criticism

Socialist critics of Lasalle 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. 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 also criticized Lasalle for misunderstanding David Ricardo.

[edit] Austrian criticism

Ludwig von Mises argues that if one adopts this reasoning in order to demonstrate that in the long run no rise in the average wage rate above the minimum is possible, one must also imply that no fall in the average rate can occur.^[2]

[edit] References

1. ^ ^{a b} Ricardo, David. On the Principles of Political Economy and Taxation chapter 5, On Wages. Library of Economics and Liberty. Retrieved on 2006-07-21.
2. ^ Money, Method, and the Market Process, Ludwig von Mises, 1967, verified 2005-04-01