Wages: Meaning, Types, Factors, Theories and Determination

In this article we will discuss about:- 1. Meaning of Wages 2. Factors Determining Real Wages 3. Causes for Wage Differences 4. Types 5. Factors 6. Theories 7. Determination of Fair Wages for Workers 8. Money Wages and Real Wages.

Meaning of Wages:

Wages are the remuneration or reward for labour. There are two main kinds of wages- (1) Nominal wages and (2) Real wages. The term ‘nominal wages’ refers to money wages. But the term ‘real wages’ refers to the commodities and services that the money wages can provide. The standard of living of workers relies on real wages and not on money wages. Real wages depend on many things like the purchasing power of money, additional benefits the workers get such as free boarding and lodging, regularity of employment, working conditions and so on. Real wage do not always raise with the money wages.

Despite of an increase in money wages, workers may be worse off if prices rise faster than money wages. So one is never sure that workers in a particular country are well off merely by looking into their money wages. But, generally when there is a reference to wages, it is the money wages.

Factors Determining Real Wages:

1. Real wages relies upon the purchasing power of money. The purchasing power of money in turn depends upon the level of price. It changes with changes in the price level.

2. Real wages depend on the form of wages. For example, a labour working as agricultural worker may get low amount of money wage but may be given free food to eat, place to stay, clothes in festivals and so on. These things should be taken into consideration while considering real wages.

3. The nature of the job and the regularity of employment is an important factor. We have to see whether the job is permanent or not. Agriculture in India provides mostly seasonal employment. A person who has a regular job has more real wages than one who has seasonal employment.

4. Possibility of extra income in some occupations has to be considered.

5. The nature of work and also the working conditions should be considered.

Causes for Wage Differences:

Wages vary from one trade or employment to another and occasionally wages vary within the same trade too.

There are many causes for differences in wages:

1. Wages differ depending on the conditions of supply. Where the supply of labor is relatively abundant, wages tend to be low.

2. Sometimes because of ignorance, workers may fail to move from ill-paid jobs to better jobs.

3. Wages differ according to the agreeableness or disagreeableness of work. People who are employed to do dangerous jobs and unpleasant work have to be paid more than those who do pleasant work. Spies, for example, are paid high wages. But sometimes people who do the most unpleasant jobs are badly paid.

4. The cost of training in some occupations is so high that only a few can enter into them. Such persons get high wages. For example, doctors and engineers get higher wages than typists do.

Wages in those occupations where trade unionism is strong will be higher than in those occupations where trade unionism is weak.

6. Even within the same trade, wages may differ because men differ in their ability. Some workers will earn more. For example, there are doctors. Only a few doctors earn very large incomes. That is sometimes described as “rent of ability”.

7. Lastly, wages also differ because of the immobility of labor. Even though workers in a particular trade will get better wages if they go to another place, they will not do so for many reasons. Of all forms of luggage, labor is the most difficult to transport.

Types of Wages:

Wages have been classified into three categories:

(1) Living wages

(2) Minimum wages

(3) Fair wages

(1) Living Wages:

Living wages has been defined differently by different people in different countries. The best definition is given by Justice Higgins which reads “Living wage is a wage sufficient to ensure the workman food, shelter, clothing, frugal comfort, provision for evil days etc. as regard for the skill of an artisan, if he is one”. Living wages means the provision for the bare necessities plus certain amenities considered necessary for the wellbeing of the workers in terms of his social status.

In India, Article 43 of the Indian Constitution states that the state shall endeavour to secure by suitable legislation or economic organization or in any other way to all workers a living wage, conditions of work ensuring a decent standard of life and full enjoyment of plea­sure and social and cultural opportunities. Thus, Government of India has adopted as one of the directives of the principle of slate policy to ensure living wages.

(2) Minimum Wages:

The minimum wage may be defined as the lowest wage necessary to maintain a worker and his family at the minimum level of subsistence, which includes food, clothing and shelter. When the government fixes minimum wage in a particular trade, the main objective is not to control or determine wages in general but to prevent the employment of workers at a wage below an amount necessary to maintain the worker at the minimum level of subsistence.

Minimum wage in a country is fixed by the government in consultation with business organizations and trade unions. The Government of India passed a Minimum Wage Act in 1948.

Minimum wages legislation is supposed to have the following benefits:

(i) These laws prevent dishonest employers from exploiting ignorant persons who possess very little bargaining power.

(ii) These abolish the competition of the lower strata of workers with the upper grades and tend to prevent depressing of wages.

(iii) The productivity of industry is increased by foreign employers to use the most efficient production methods and the most modern equipment, in order to enable employees to earn the living wage. But at the same time, the workers are stimulated to increase his efficiency in order to hold his job.

(iv) Employers with high standards are protected against underselling by competitors with low standards.

(3) Fair Wages:

A fair wage is something more than the minimum wages. Fair wage is a mean between the living wage and the minimum wage. While the lower limit of the fair wage must obviously be the minimum wage, the upper limit is the capacity of the industry to pay fan- wage compares reasonably with the average payment of similar task in other trades or occu­pations requiring the same amount of ability. Fair wage depends on the present economic position as well as on its future prospects.

Factors Affecting Wages:

Following are the factors which affect the determination of wages:

1. Supply and demand of labour;

2. The organisation’s ability to pay;

3. The prevailing market rate;

4. The cost of living;

5. Living wage;

6. Trade Union’s bargaining power;

7. Productivity;

8. Job requirements;

9. Managerial attitudes;

10. Psychological and Sociological factors.

1. Supply and Demand of Labour:

The labour market conditions or supply and demand forces operate at the national, regional and local levels, and determine organisational wage structure and level. If the demand for certain skills is high and the supply is low the result is a rise in the price to be paid for these skills. When prolonged and acute, these labour-market pressures probably force most organisations to “reclassify hard-to-fill jobs at a higher level” than that suggested by the job evaluation.

The other alternative is to pay higher wages if the labour supply is scarce; and lower wages when it is excessive. Similarly, if there is great demand for labour expertise, wages rise; but if the demand for manpower skill is minimal, the wages will be relatively low.

2. The Organisation’s Ability to Pay:

Wage increases should be given by those organisations which can afford them. Companies that have good sales and, therefore, high profits tend to pay higher wages than those which running at a loss or earning low profits because of the high cost of production or low sales. In the short run, the economic influence on the ability to pay is practically nil.

All employers, irrespective of their profits or losses, must pay no less than their competitors and need pay no more if they wish to attract and keep workers. In the long run, the ability to pay very important. During time of prosperity, employers pay high wages to carry on profitable operations and because of their increased ability to pay.

3. Prevailing Market Rate:

This is also known as the ‘comparable wage’ or ‘going wage rate’, and is the most widely used criterion. An organisation’s compensation policies generally tend to conform to the wage-rates payable by the industry and the community. This is done for several reasons. First, competition demands that competitors adhere to the same relative wage level. Second, various government laws and judicial decisions make the adoption of uniform wage rates an attractive proposition.

Third, trade unions encourage this practice so that their members can have equal pay equal work and geographical differences may be eliminated. Fourth, functionally related firms in the same industry require essentially the same quality of employees, with the same skills and experience. This results in a considerable uniformity in wage and salary rates.

4. The Cost of Living:

The cost-of-living pay criterion is usually regarded as an automatic minimum equity pay criterion. This criterion calls for pay adjustments based on increases or decreases in an acceptable cost of living index. In recognition of the influence of the cost of living, “escalator clauses” are written into labour contracts. When the cost of living increases, workers and trade unions demand adjusted wages to offset the erosion of real wages.

5. The Living Wage:

The Living Wage criterion means that wages paid should be adequate to enable an employee to maintain himself and his family at a reasonable level of existence. However, employers do not generally favour using the concept of a living wage as a guide to wage determination because they prefer to base the wages of an employee on his contribution rather than on his need.

6. Trade Union’s Bargaining Power:

Trade unions do affect rate of wages. Generally, the stronger and more powerful the trade union, the higher the wages. A trade union’s bargaining power is often measured in terms of its membership, its financial strength and the nature of its leadership. A strike or a threat of a strike is the most powerful weapon used by it. Sometimes trade unions force wages up faster than increases in productivity would allow and become responsible for unemployment or higher prices and inflation.

7. Productivity:

Productivity is another criterion, and is measured in terms of output per man-hour. It is not due to labour efforts alone. Technological improvements, better organisation and management, the development of better methods of production by labour and management, greater ingenuity and skill by labour are all responsible for the increase in productivity.

Actually, productivity measures the contribution of all the resource factors-men, machines, methods, materials and management. No productivity index can be devised which will measure only the productivity of a specific factor of production. Another problem is that productivity can be measured at several levels— job, plant, industry or national, economic level.

8. Job Requirements:

Generally, the more difficult a job, the higher are the wages. Measures of job difficulty are frequently used when the relative value of one job to another in an organisation is to be ascertained.

9. Managerial Attitudes:

These have a decisive influence on the wage structure and wage level since judgment is exercised in many areas of wage and salary administration—including whether the firm should pay below average, or above average rates, what jobs factors should be used to reflect job worth, the weight to be given for performance or length of service, and so forth, both the structure and level of wages are bound to be affected accordingly.

10. Psychological and Social Factors:

These determine in a significant measure how hard a person work for the compensation received or what pressures he will exist to get his compensation increased. Psychologically, persons perceive the level of wages as a measure of success in life; people may feel secure, have an inferiority complex, seem inadequate or feel the reverse of all these. They may or may not take pride in their work, or in the wages they get.

Therefore, these things should not be overlooked by the management in establishing wage rates. Sociologically and ethically, people feel that equal work should carry equal wages, that wages should be commensurate with their efforts that they are not exploited and that no distinction is made on the basis of caste, colour or sex or religion.

Major Theories of Wages:

Since the time of Adam Smith and even earlier, economists have formulated different theories of wages. Smith himself, along with others of the classical school, believed in a natural wage, determined solely by supply and demand. The minimum wage must be a subsistence wage (sufficient for survival), but when demand for labor rose, wages would rise above this minimum.

Less optimistic theorists, such as David Ricardo, believed that wages always tend to remain at the bare subsistence level (i.e. Iron Law of Wages). John Stuart Mill and other saw wages as determined by the number of workers who must share a fixed quantity of capital set aside by entrepreneurs (i.e. Wages Fund Theory). The marginalists devised the marginal productivity theory of wages, linking wages to workers’ productivity.

The bargaining theory of wages, developed when labor unions grew more powerful, holds that wages are never higher than the capitalist’s break-even point or lower than the workers subsistence level, but exactly where between those two points their fall depends on the relative bargaining power of capitalists and of workers. Most present-day economists would agree that the broad, overall level of wages is determined by a complex interplay of many forces, which in turn influences the supply of wages and demand for labor.

Wages are a payment for the services of labor. In this background, several theories were advanced from time to time to explain the determination of wage rate.

Among other theories of wages, the important are the following:

1. Subsistence Theory

2. Wages Fund Theory

3. Residual Claimant Theory

4. Marginal Productivity Theory

5. The Demand and Supply Theory of Wages.

1. Subsistence Theory of Wages:

Many of the Classical economists have popularized this theory. According to this theory, the general level of wages in the long run, is equal to the subsistence level (i.e. food, cloth and shelter), which is the level of bare necessities.

2. Wages Fund Theory:

This theory was propounded by J.S. Mill. According to this theory, the general rate of wages can be found by dividing the wage fund set apart by the employer by the number of workers.

3. Residual Claimant Theory:

This theory was propounded by Prof. Walker. This theory states that wage are of the nature of a residue and the worker is to get what remains after other agents of production have been paid.

4. Marginal Productivity Theory of Wages:

The marginal productivity theory of wages, developed by J.B. Clark, is based on the assumption of pure competition in both commodity and labor markets. In both the markets the buyers and sellers are supposed to be price-takers. In brief, the marginal productivity theory of wages states that under perfect competition, wages are determined by the value of the marginal product of labor.

5. The Demand and Supply Analysis:

This is the modern theory of wages, provides a satisfactory explanation of the wage determination. According to this theory, the price of labor is determined by the market forces of demand and supply.

Determination of Fair Wages for Workers:

Theoretically, it is very easy to define fair wages but practically the determination of fair wages is not easy as to define it.

The rules and the problems in the process of determination of Fair Wages are as follow:

(1) Determination on the Basis of Paying Capacity of the Industry:

According to this technique, fair wages should depend upon the paying capacity of the Industry. But it is very difficult to determine and define the paying capacity of an industry.

Generally, the paying capacity of an industry estimated on the basis of net profits of the enterprise, but following are the difficulties in adopting this method as the base of determination of fair wages:

(i) The amount of profits may be substantially reduced by increasing the provision for depreciation and other provisions and reserves.

(ii) Similarly, the amount of profits may be increased or decreased by increasing or decreasing the expenses.

Considering these difficulties, Fair Wages Committee has suggested that the paying capacity of an enterprise must be related with the current rate of wages.

Following are the basis of measuring paying capacity of an industry on this base:

(i) Purchase Price:

A certain purchase price of commodities is taken to be the central point and the rate of wage is determined on the basis of this purchase price. The rate of wage is increased or decreased in proportion to the increase or decrease in this purchase price.

(ii) Profit of the Enterprise:

According to this technique of measuring paying capacity of an enterprise, a certain amount of profits is taken to be central point and the rate of wages is primarily determined on the basis of this amount of profits. If rate of profits is higher, it means that the paying capacity of the enterprise is more and if the rate of profits is lower; it means that the paying capacity of the enterprise is less.

(iii) Quantity of Production:

According to this technique, rate of wage is primarily determined on the basis of a certain quantity of production and this rate of wage is further increased or decreased on the basis of increased or decreased on the basis of increase or decrease in the quantity of production.

(iv) Unemployment:

Under this technique, rate of wage is primarily determined on the basis of certain level of unemployment and this rate is further increased or decreased according to the increase or decrease in the level of the employment.

(2) Difficulty in the Execution of Fair Wages:

Following are the difficulties in the execution of fair wages:

(i) Under time wage payment system, the rate of wage is determined after considering the efficiency of labour but it is not necessary that all the employees work with the same efficiency and ability,

(ii) Under piece-wage system, it is comparatively easier to relate the payment of wages with the efficiency of workers but under this system of wage payment it is necessary that the working conditions of all the workers getting equal rate of wage must be similar.

(3) Determination on the Basis of Productivity of the Industry:

Rate of wage is closely related with the productivity of labour. Productivity of labour does not depend upon the efficiency of labour only. It depends upon many other factors also, such as— managerial capacity, financial management and technical facilities etc. Therefore, these factors must also be considered while determining the rate of wage on the basis of productivity and labour.

The Human Capital Approach to Wages:

Trained labour is a combination of unskilled labour and investments of time and money. This is why trained labour can be viewed as human-capital. If the flow of trained labour is to be ensured in the long run, its price must cover both the ‘human’ and the capital costs. That is to say, the price of trained labour must cover the wage of unskilled labour plus the interest on the time and money invested in it.

Training needs an investment of both money and time. Time is also money, since the time spent in training can alternatively be devoted to earning wages of untrained labour. Thus, the incomes forgone during the training period, and the extra money expenses during training, together constitute the capital invested in trained labour.

However, there is a slight hitch in estimating this capital. This is because the training expenses and incomes forgone are spread over different periods of time. Hence, before adding them up, the expenses of and incomes forgone in earlier periods must be revised upwards. This is because they could have earned interest in the meantime.

Thus, each period’s expenses and forgone incomes must be weighted by a growth coefficient reflecting the rate of interest. The sum of all these weighted estimates gives us the present value of the capital invested in training. The wage of trained labour must cover the interest burden of this capital as well as the wage rate of unskilled labour.

Algebraically,

where w_t = wage rate of trained labour

w₀ = wage rate of untrained labour

r = rate of interest

E_i = training expenses in the ith year of training

n = number of years of training

This equation gives the supply price of trained labour. Below this price, the flow of newly trained labour will dry up in the long run. This equation also explains why the price of trained labour goes up with the wages of unskilled labour (parity argument), the period of training and the rate of interest. It also suggests that compared to school children, higher wages will have to be offered to induce adults to undergo training, since the former forgoes no incomes during the training period.

Based on the above equation, a model of long run price determination of trained labour can be set out as in Fig. 14.2. D is the demand curve for newly trained labour. S is the long run supply curve of freshly trained labour. S is infinitely elastic at w_t until N. Beyond N, however, a higher wage than w_t has to be paid to attract persons away from other avocations, or to overcome any possible distaste for the job under study.

The human capital approach to the pricing of labour is closely interwoven with the theory of interest.

Money Wages and Real Wages:

Money Wages:

Money wages is also called nominal wages. Money wage means the payment made to workers in terms of money. According to Professor Thomas, “Nominal wages or nominal earnings refer to the amount of wage as measured in terms of money.” For example, a labour is paid Rs. 60 per day then it is called money wages. Money wages are calculated in terms of money paid either for mental labour or physical labour to worker.

Real Wages:

When the money wages are expressed in terms of goods and services and the facilities provided by an employer to the workers. In other words, real wages mean money wages plus other facilities given to the worker like housing facility, free electricity and water facilities, medical and educational facilities and conveyance given by the employer to the workers.

According to Professor Thomas, “Real wages refer to ‘net advantage’ of the worker’s remuneration, i.e., the amount of the necessaries, comforts and luxuries of life which the worker can command in return for his services.”

Thus, real wages are calculated on the basis of the following formula:

Real Wages = Money wages in term of goods and services + Other facilities provided by the employer.

Money wages and real wages do not move in the same direction. When money wages are raised but the prices are increasing it will decrease the real wages because the purchasing power of money is decreasing. Contrary to it, when money wages are increased by the employer by providing various facilities in terms of housing, medical and educational facilities, recreational facilities, free water and electricity, conveyance allowances, etc., the workers will be better off.

During deflationary situation the real wage increases due to fall in the prices of goods and services. Thus, the workers may be better or worse off depending upon the level of real wages and not on money wages.