Wage fund theory

The wage fund theory is understood in classical economics to be a theory according to which the wages of a worker result from the quotient of a fixed wage fund and the total number of workers within an economy .

The wage fund theory

The wage fund theory, in its extreme form, can initially be reduced to the descriptive mathematical formula

{\ displaystyle {\ text {l}} = {\ frac {\ text {L}} {\ text {A}}}}

to reduce. Accordingly, the wage rate is obtained by dividing the wage fund by the number of workers . In order to understand the content of the individual terms, all explanations must be read against the background that they are macroeconomic terms. This means that every term refers to the context of an entire society and not to individual cases. The wage rate is therefore the average income of all employed people in an unspecified period. What is important here is the reference to people who work in dependent relationships; the wage rate does not include the income of all self-employed entrepreneurs and farmers. The number of workers describes all members of a state who are employed. This means that non-employed women and children as well as the self-employed and farmers are excluded from this group. The group of the unemployed is also not covered by this term, since according to the classic view , unemployment was only a temporary phenomenon, but did not exist in the long term. ${\ displaystyle l}$ ${\ displaystyle L}$ ${\ displaystyle A}$

However, the central and hardest to describe term within the theory is the wage fund itself. John Stuart Mill defines the wage fund as “only circulating capital, and not even its entire amount, but only that part of it that is intended for the direct purchase of labor. But we have to add all funds which are paid in exchange for labor without forming part of the capital, such as the wages of soldiers, domestic servants and all other unproductive workers. (…) Since the wages of the productive workers make up almost the whole of this fund, it is customary to ignore the smaller and less important part (…) ”. Mill differentiates between productive work, that is, all work that ends with a product, and unproductive work, which includes all services. In modern terms, this is the distinction between the secondary and tertiary economic sectors. Since the tertiary sector of services was only very poorly developed in Mills' time, he omits this as a "less important part" and thereby simplifies his theory. Budge later tries to explain the wage fund as the “amount of value that can be converted into workers' consumables within an economic area, depending on the productivity of labor, at a given moment and not in the course of a production period”. The wage fund is therefore a given amount of capital. The wage fund theory model simplifies the wage fund in that it is a given amount of capital in the hands of employers that is paid out to the workers at a certain point in time. The payment takes place before the work to be performed, as the amount of capital is given and does not arise in the course of the production process or the work. The wage fund theory does not give any information about where exactly the amount of capital comes from, it is only ascribed to the entrepreneurs. It also remains open for which period of time the wages are paid. It is not specified whether the capital is money or other goods that are spent on the workers. This makes the wage fund a fictitious simplification within a model.

After defining the terms, the operation of the wage fund theory is easy to explain mathematically. The wage rate is determined as a dependent variable on the independent variables of the wage fund and the number of workers. If the wage rate is to be changed, the value of at least one of the two output variables must be increased or decreased. For an increase in the wage rate, either the wage fund must increase while the number of workers falls or remains constant, or the number of workers must decrease while the wage fund remains constant or increases. For a falling wage rate, either the wage fund must decrease while the number of workers remains constant or increase, or the number of workers must increase while the wage fund remains constant or decreases. If both effects work in the same direction, i.e. a rising wage fund with a simultaneous increase in the number of workers, or a falling wage fund with a falling number of workers, the stronger effect decides whether the wage rate rises or falls. A wage rate that remains constant is also possible if both effects are equally strong.

In recent literature, Englberger emphasizes the greater importance of labor demand for the level of the wage rate. This replaces the labor supply, which in earlier theories was considered the determinant of wages. This stronger emphasis on the demand side only found its way into teaching through criticism of the original wage fund theory.

Origin and application

According to the mathematical functioning, the entrepreneurs should primarily have the possibility of influencing the level of the wage rate by controlling the demand for labor . Furthermore, by lowering the number of their offspring, the workforce could lower the future number of workers and thus increase their wage rate. Likewise, through harder work, it could increase productivity in the first period, so that the additional capital generated could increase the wage fund in the following period. At the same time, the entrepreneurs could support an increase in the wage fund through increased savings and thereby raise wages. In fact, however, the classics assume that only the workers have the opportunity to improve their own situation. As a justification, John Stuart Mill refers to the Malthusian population law, one of the forerunners and theoretical foundations of the wage fund theory. Accordingly, the population of a state is limited by the amount of food available. As this amount increases, the population increases too. If the population increases disproportionately to the amount of food, this leads to the impoverishment of the population. Poverty results in fewer births, so that the population then declines again until it reaches a reasonable level. For their part, the poor population is always trying to produce as many offspring as possible. As a result, whenever the food situation permits, the population will multiply and remain at the same level of supply in the long term. Only temporary increases in the quality of life are conceivable until new offspring are produced. Malthus transfers this to his idea of the wage fund theory in such a way that a rising wage fund will meanwhile mean a rising wage rate. However, this higher wage rate is not used by the workers to afford a higher standard of living, but instead to father more children. As a result, a higher number of workers will be available every generation, which will destroy the previous increase in the wage fund.

This leaves the development of the wage rate in the hands of the workers alone, while the employers are free from any responsibility for their employees. Any increase in the wage rate caused by an increase in the wage fund will be wiped out in the next generation by more births and the associated increase in the number of workers. Therefore, the only practical way to increase the wage rate remains to reduce the number of workers, or at least keep it constant as long as the wage fund rises.

The results of this theoretical discussion were then taken up in practice, mainly by employers, who thus justified the pointlessness of wage negotiations. Accordingly, a wage increase would not be able to increase the total wage bill, i.e. the wage fund, but instead lead to a lower demand for work. This also largely rendered the benefits of unions that pursued the goal of higher wages obsolete. Although John Stuart Mill was generally positive about such associations, a wage increase was "completely unattainable by such means". The only possible goal of a union could be to reduce working hours overall while keeping wages constant. An increase in wages would inevitably lead to unemployment .

Within the political discourse, the wage fund theory was used to argue against government measures to combat poverty. The British government's poor laws and grain subsidies would lead to an increase in disposable income and thus the living standards of the workers in the short term, but in the long term the measures would have no effect and would even worsen the situation. To this end, the wage fund theorists once again invoked Malthus's population law, according to which the higher wages are used in the long term to produce more offspring in the future and not to keep the standard of living higher. However, with the increase in the number of workers following a generation later, wages would fall back below the original level. The new lower wage level, together with the state social measures, would create the same livelihood as before wages without state measures.

Criticism and replacement

Directly related to the lives of millions of workers, the wage fund theory subsequently sparked heated discussion. Especially because of her rejection of unions and wage negotiations, she aroused severe criticism from British trade unionists. The scientific discourse on theory also began. Before everyone else, Hermann wrote a criticism of the wage fund theory in Germany in 1832, which was further refined by Brentano and led to the fact that from this point onwards hardly any German economist followed the doctrine of the wage fund.

Both Hermann and Brentano focus in their criticism on the wage fund itself. Hermann criticizes that the wage fund is not capital that is provided by the entrepreneurs. Instead, the wage fund is fed from the income of the consumers who buy the finished products. It is thus the consumers and also the workers themselves who feed the wage fund and provide the capital for workers' wages. The wage fund is also described as a "source", so it is continuously fed and paid out. With this criticism, there is a change in the possible wage rate. The entrepreneurs only take on an intermediate role in the work process, in that they buy people's labor and then sell it to consumers afterwards, converted into products. This means that higher wages can simply be passed on to consumers and no longer have to be paid for by the capital that employers provide in the wage fund. Brentano later added two further points to this criticism. Firstly, it is possible at any time to expand the wage fund by restricting private consumption. Second, the entrepreneur is always able to pay a higher wage by borrowing. With this one of the central theses of the wage fund, namely the immutability of the wage fund amount by the entrepreneurs, is refuted by Brentano and Hermann.

Brentano also attacks the concept of work on which the wage fund theory is based. John Stuart Mill also describes the mathematical quotient of the wage fund and the number of workers as the relationship between supply and demand for labor. In doing so, he declares the labor market, like any other market, to be a market that is based on supply and demand and thus always tends towards a market equilibrium. If the supply of work is greater than the demand, the price will fall until it is worthwhile for the entrepreneur to ask for more work. At the same time, some people will no longer offer their labor on the market because the price they can get is too low. This ultimately creates a balance where there is no unemployment. As already stated, John Stuart Mill warns of wage demands by the unions that are above the wage rate resulting from his theory, as these would lead to unemployment. This assumption is countered by Brentano, who sees the wage rate not as the result of supply and demand, but as determined by the competition between workers. With this, Brentano gives the unions another task, namely to achieve the highest possible wage rate for the group of workers they represent. In accordance with its assumption, the increased wage rate is passed on to the consumers who feed the wage fund. These, however, are not exclusively other workers, but also the other social classes. Thus, the wage increase of one group of workers would not automatically lead to an equal decrease in wages for the rest of the workers and would increase the average wage rate of the workers overall. Brentano thus opposes the opinion that the work of unions is in vain in the long term. Likewise, one of John Stuart Mill's assumptions is countered. To simplify his definition of the wage fund, Mill had set only the amount of capital intended to pay the workers' wages. Brentano is now including the rest of society as consumers in the wage fund.

Overall, Hermann and Brentano point out some of the weaknesses of the wage fund theory without, however, completely refuting them. Instead, they modify the wage fund and place responsibility for wages in the hands of employers. In doing so, they create a new wage fund theory that is a further development of the old theory. However, these remarks do not make the leap to England to revive the scientific discussion there. Only decades later did Longe and Thornton begin to criticize the wage fund theory, which in many respects is similar to that of Hermann and Brentano, but does not rely on it. Instead, the criticism is based on the fact that reality can no longer be explained with the help of theory.

Longe and Thornton criticize both assumptions about the wage fund and the perception of work. First, Longe attacks the wage fund and finds that it does not exist as a fixed figure. At most, the wage fund indicates what wages can be paid. Longe notes that not the entire wage fund is actually spent on the demand for work. In addition, the size of the wage fund results from the entrepreneurs' estimate of how strong the demand for the end product will be. Longe therefore sees the size of the wage fund largely influenced by consumers. Thornton continues Longes' idea and later denies the existence of a wage fund and leads to a thought experiment. According to this, no entrepreneur finds a lot of money that he must necessarily spend on his workers. Rather, every entrepreneur determines how much he can spend at the maximum and then tries to spend as little as possible on his workers. Since there does not appear to be a wage fund at the corporate level, Thornton sees no national wage fund either.

Second, Longe and Thornton deal with the concept of work within the wage fund theory. The workforce does not result in a uniform mass with an "average worker" to whom the wage fund is divided. Therefore, the wage level does not result from the interplay of supply and demand for labor, but from competition between workers. This opinion is similar to that of Hermann and Brentano. In the next step, however, he limits this assumption again by distinguishing work from ordinary products, since work is always offered at any price. This is not the case with other products. In this way, the employers ultimately determine the level of the wage rate by determining the amount of work requested. With this, Thornton contradicts his original statement, according to which there is no wage fund, by seeing a connection between the amount of wages and the work demanded. According to him, there must be a fund from which a certain number of workers are paid.

Thornton and Longe do not refute the wage fund theory either. Instead, they point out some of their weaknesses with their criticism and develop them further with their own solution approaches. As before in Germany, the critical scientific discussion is getting started in Great Britain. John Stuart Mill, who, after his father, was regarded as the perfecter of the wage fund theory, uses Thornton's criticism to turn away from the theory of the wage fund and to turn to the “standard-of-life theory”. This is commonly recorded as the point in time at which the wage fund theory lost its leading position within science to explain wages. However, this does not mean that it was no longer the subject of scientific research. In 1896, for example, FW Taussig tried an improved reformulation of the wage fund theory, where he also went into the criticism of the original theory. Nevertheless, in the end he fails mainly because he tries too much to explain wage formation from the point of view of the entrepreneur. He completely ignores the demand side and pays little attention to the market situation.

literature

JOHN, HEINZ (1937), history and criticism of the wage fund theory , Carl Nieft Verlag, Bleichrode am Harz.

ENGLBERGER, JOSEF (1995), Die Lohnfondstheorie , in: Tarifautonomie im Deutschen Reich: Development of the collective bargaining system in Germany from 1870/71 to 1945, Duncker & Humblot, Berlin, pp. 58–61.

KRUMBACHNER, JOSEF (1991), James Mills ' wage fund theory , in: History of Economic Theory , Verlag für Wirtschaftsskripten, Munich, pp. 98-100.

KRUSE, ALFRED (1959), The Development of the Wage Fund Theory, in: History of Economic Theories, Duncker & Humblot, Berlin, pp. 100-104.

SCHREY, MARY DR. (1913), The Wage Law of Classical Economics, in: Critical Dogmen History of the Ehernen Lohngesetzes, Verlag Gustav von Fischer, Jena, pp. 25–49.

TAUSSIG, FW (1896), Chapter XIII The Wages Fund In Germany , in: Wages and Capital: An Examination of the Wages Fund Doctrine, Macmillan and Co., New York, reprinted by University Microfilms International, Ann Arbor, Michigan, USA, London, England (1980), pp. 266-281.