The Irrelevance of “Worker Need” and “Employer Greed” in the Determination of Wages
While Adam Smith originated the doctrine that profits are a deduction from what is naturally and rightfully wages, Marx carried that doctrine to its ultimate limit, in the claim that the greed of the capitalists drives them to deduct so much from what rightfully belongs to the wage earners that the latter are left only with minimum subsistence. This is Marx’s version of the so-called “iron law of wages.” Its essential claim is that employers have the power arbitrarily to set wages at minimum subsistence, irrespective of the state of capital accumulation, technology, and the productivity of labor.1
What makes Marx’s doctrine of the alleged arbitrary power of employers over wages appear plausible is that there are two obvious facts which do not actually support it but which appear to support it. These facts can be described as “worker need” and “employer greed.”
The average worker must work in order to live, and he must find work fairly quickly, because his savings cannot sustain him for long. And if necessary—if he had no alternative—he would be willing to work for as little as minimum physical subsistence. At the same time, self-interest makes employers, like any other buyers, prefer to pay less rather than more—to pay lower wages rather than higher wages. People put these two facts together and conclude that if employers were free, wages would be driven down by the force of the employers’ self-interest—as though by a giant plunger pushing down in an empty cylinder—and that no resistance to the fall in wages would be encountered until the point of minimum subsistence was reached. At that point, it is held, workers would refuse to work because starvation without the strain of labor would be preferable to starvation with the strain of labor. Thus, if the capitalist is to find workers, he must pay them at least minimum subsistence and no less.
What must be realized is that while it is true that workers would be willing to work for minimum subsistence if necessary and that self-interest makes employers prefer to pay less rather than more, both of these facts are irrelevant to the wages the workers actually have to accept in the labor market.
Let us start with “worker need.” To understand why a worker’s willingness to work for subsistence if necessary is irrelevant to the wages he actually has to work for, consider the case of the owner of a late-model car who decides to accept a job offer, and to live, in the heart of New York City. If this car owner cannot afford several hundred dollars a month to pay the cost of keeping his car in a garage, and if he cannot devote several prime working hours every week to driving around, hunting for places to park his car on the street, he will be willing, if he can find no better offer, to give his car away for free—indeed, to pay someone to come and take it off his hands. Yet the fact that he is willing to do this is absolutely irrelevant to the price he actually must accept for his car. That price is determined on the basis of the utility and scarcity of used cars—by the demand for and supply of such cars. Indeed, so long as the number of used cars offered for sale remained the same, and the demand for used cars remained the same, it would not matter even if every seller of such a car were willing to give his car away for free, or willing even to pay to have it taken off his hands. None of them would have to accept a zero or negative price or any price that is significantly different from the price he presently can receive.
This point is illustrated in terms of the simple supply and demand diagram presented in Figure 1. On the vertical axis, I depict the price of used cars, designated by P. On the horizontal axis, I depict the quantity of used cars, designated by Q, that sellers are prepared to sell and the buyers to buy at any given price. The willingness of sellers to sell some definite, given quantity of used cars at any price from zero on up (or, indeed, from less than zero by the cost of having the cars taken off their hands) is depicted by a vertical line drawn through that quantity. The vertical line SS denotes the fact that sellers are willing to sell the specific quantity A of used cars at any price from something less than zero on up to as much as they can get for their cars.
The fact that the sellers are willing to sell for zero or a negative price has nothing whatever to do with the actual price they receive, which in this case is the very positive price P1. The actual price they receive in a case of this kind is determined by the limitation of the supply of used cars, together with the demand for used cars. In Figure 1, it is determined at point E, which represents the intersection of the vertical supply line with the downward sloping demand line.2
The price that corresponds to that juncture of supply and demand is P1. The fact that the sellers are all willing if necessary to accept a price less than P1 is, as I say, simply irrelevant to the price they actually must accept. The price the sellers receive in a case of this kind is not determined by the terms on which they are willing to sell. Rather, it is determined by the competition of the buyers for the limited supply offered for sale. This, of course, is the kind of case that the great Austrian-school economist Böhm-Bawerk had in mind when he declared that “price is actually limited and determined by the valuations on the part of the buyers exclusively.”3
Essentially the same diagram, Figure 2, depicts the case of labor. Instead of showing price on the vertical axis, I show wages, designated by W. Instead of the supply line being vertical to the point of the sellers being willing to pay to have their good taken off their hands, I assume that no supply whatever is offered below the point of “minimum subsistence,” M. This is depicted by a horizontal line drawn from M and parallel to the horizontal axis. Thus, the supply “curve” in this case has a horizontal portion at “minimum subsistence” before becoming vertical. These are the only differences between Figures 1 and 2.
Figure 2 makes clear that the fact that the workers are willing to work for as little as minimum subsistence is no more relevant to the wages they actually have to accept than was the fact in the previous example that the sellers of used cars were willing to give them away for free or pay to have them taken off their hands. For even though the workers are willing to work for as little as minimum subsistence, the wage they actually obtain in the conditions of the market is the incomparably higher wage W1, which is shown by the intersection—once again at point E—of the demand for labor with the limited supply of labor,noted by point A on the horizontal axis. Exactly like the value of used cars, or anything else that exists in a given, limited supply, the value of labor is determined on a foundation of its utility and scarcity, by demand and supply—more specifically, by the competition of buyers for the limited supply—not by any form of cost of production, least of all by any “cost of production of labor.”
It also quickly becomes clear that “employer greed” is fully as irrelevant to the determination of wage rates as “worker need.” This becomes apparent as soon as the case of the art auction is considered that I originally presented in Capitalism4 in order to demonstrate the actual self-interest of buyers. There I assumed that there are two people at an art auction, both of whom want the same painting. One of these people, let us now call him Mr. Smith, is willing and able to bid as high as $2,000 for the painting. The other, let us now call him Mr. Jones, is willing and able to go no higher than $1,000. Of course, Mr. Smith does not want to spend $2,000 for the painting. This figure is merely the limit of how high he will go if he has to. He would much prefer to obtain the painting for only $200, or better still, for only $20, or, best of all, for nothing at all. What we must consider here is precisely how low a bid Mr. Smith’s rational self-interest allows him to persist in. Would it, for example, actually be to Mr. Smith’s self-interest to persist in a bid of only $20, or $200?
It should be obvious that the answer to this question is decidedly no! This is because if Mr. Smith persists in such a low bid, the effect will be that he loses the painting to Mr. Jones, who is willing and able to bid more than $20 and more than $200. In fact, in the conditions of this case, Mr. Smith must lose the painting to the higher bidding of Mr. Jones, if he persists in bidding any sum under $1,000! If Mr. Smith is to obtain the painting, the conditions of the case require him to bid more than $1,000, because that is the sum required to exceed the maximum potential bid of Mr. Jones.
This case contains the fundamental principle that names the actual self-interest of buyers. That principle is that a buyer rationally desires to pay not the lowest price he would like or can imagine, but the lowest price that is simultaneously too high for any other potential buyer of the good, who would otherwise obtain the good in his place. Here that minimum price is $1,001.
This identical principle, of course, applies to the determination of wage rates. The only difference between the labor market and the auction of a painting is the number of units involved. Instead of one painting with two potential buyers for it, there are many millions of workers who must sell their services, together with potential employers of all those workers and of untold millions more workers. This is because just as in the example of the art auction, the essential fact that is present in the labor market is that the potential quantity demanded exceeds the supply available. The potential quantity of labor demanded always far exceeds the quantity of labor that the workers are able, let alone willing, to perform.
For labor, it should be realized, is scarce. It is the most fundamentally useful and scarce thing in the economic system: virtually everything else that is useful is its product and is limited in supply only by virtue of our lack of ability or willingness to expend more labor to produce a larger quantity of it. (This, of course, includes raw materials, which can almost always be produced in larger quantity by devoting more labor to the more intensive exploitation of land and mineral deposits that are already used in production, or by devoting labor to the exploitation of land and mineral deposits that are known but not presently exploited.)5
For all practical purposes there is no limit to our need and desire for goods or, therefore, for the performance of the labor required to produce them. In having, for example, a need and desire to be able to spend incomes five or ten times the incomes we presently spend, we have an implicit need and desire for the performance of five or ten times the labor we presently perform, for that is what would be required in the present state of technology and the productivity of labor to supply us with such increases in the supply of goods. Moreover, almost all of us would welcome the full-time personal services of at least several other people. Thus, on both grounds labor is scarce, for the maximum amount of labor available to satisfy the needs and desires of the average member of the economic system can never exceed the labor of just one person. Indeed, in actual practice, it falls far short of that amount, because of the existence of large numbers of people, such as infants, small children, the elderly, and the sick, who are unable to work.
The consequence of the scarcity of labor is that wage rates in a free market can fall no lower than corresponds to the point of full employment . At that point the scarcity of labor is felt, and any further fall in wage rates would be against the self-interests of employers, because then a labor shortage would exist. Thus, if somehow wage rates did fall below the point corresponding to full employment, it would be to the self-interest of employers to bid them back up again.6
These facts can be shown in the same supply and demand diagram I used to show the irrelevance to wage determination of workers being willing to work for subsistence. Thus, Figure 3 shows that if wage rates were below their market equilibrium of W1, which takes place at the point of full employment, denoted by E—if, for example, they were at the lower level of W2—a labor shortage would exist. The quantity of labor demanded at the wage rate of W2 is B. But the quantity of labor available—whose employment constitutes full employment—is the smaller amount A. Thus, at the lower wage, the quantity of labor demanded exceeds the supply available by the horizontal distance AB.
The shortage exists because the lower wage of W2 enables employers to afford labor who would not have been able to afford it at the wage of W1, or it enables employers who would have been able to afford some labor at the wage of W1 to now afford a larger quantity of labor. To whatever extent such employers employ labor that they otherwise could not have employed, that much less labor remains to be employed by other employers, who are willing and able to pay the higher wage of W1.
At the artificially low wage of W2 the quantity AB of labor is employed by employers who otherwise could not have afforded to employ that labor. The effect of this is to leave an equivalently reduced quantity of labor available for those employers who could have afforded the market wage of W1. The labor available to those employers is reduced by AC, which is precisely equal to AB. This is the inescapable result of the existence of a given quantity of labor and some of it being taken off the market by some employers at the expense of other employers. What the one set gains, the other must lose. Thus, because the wage is W2 rather than W1, the employers who could have afforded the market wage of W1 and obtained the full quantity of labor A are now able to employ only the smaller quantity of labor C, because labor has been taken off the market by employers who depend on the artificially low wage of W2.
The employers who could have afforded the market wage of W1are in identically the same position as the bidder at the art auction who is about to see the painting he wants go to another bidder not able or willing to pay as much. The way to think of the situation is that there are two groups of bidders for quantity AB of labor: those willing and able to pay the market wage ofW1, or an even higher wage—one as high as W3—and those willing and able to pay only a wage that is below W1—a wage that must be as low as W2. In Figure 3, the position of these two groups is indicated by two zones on the demand line (or demand “curve”): an upper zone HE and a lower zone EL. The wage of W1is required for the employers in the upper zone to be able to outbid the employers in the lower zone.
The question is: Is it to the rational self-interest of the employers willing and able to pay a wage of W1, or higher, to lose the labor they want to other employers not able or willing to pay a wage as high as W1? The obvious answer is no. And the consequence is that if, somehow, the wage were to fall below W1, the self-interest of employers who are willing and able to pay W1or more, and who stood to lose some of their workers if they did not do so, would lead them to bid wage rates back up to W1. The rational self-interest of employers, like the rational self-interest of any other buyers, does not lead them to pay the lowest wage (price) they can imagine or desire, but the lowest wage that is simultaneously too high for other potential employers of the same labor who are not able or willing to pay as much and who would otherwise be enabled to employ that labor in their place.
The principle that it is against the self-interest of employers to allow wage rates to fall to the point of creating a labor shortage is illustrated by the conditions which prevail when the government imposes such a shortage by virtue of a policy of price and wage controls. In such conditions, employers actually conspire with the wage earners to evade the controls and to raise wage rates. They do so by such means as awarding artificial promotions, which allow them to pay higher wages within the framework of the wage controls.
The payment of higher wages in the face of a labor shortage is to the self-interest of employers because it is the necessary means of gaining and keeping the labor they want to employ. In overbidding the competition of other potential employers for labor, it attracts workers to come to work for them and it removes any incentive for their present workers to leave their employ. This is because it eliminates the artificial demand for labor by the employers who depend on a below-market wage in order to be able to afford labor. It is, as I say, identically the same in principle as the bidder who wants the painting at an auction raising his bid to prevent the loss of the painting to another bidder not able or willing to pay as much. The higher bid is to his self-interest because it knocks out the competition. In the conditions of a labor shortage, which necessarily materializes if wage rates go below the point corresponding to full employment, the payment of higher wages provides exactly the same benefit to employers.
- 1. In contrast to Marx, the “iron law of wages” propounded by the classical economists was not based on any claim of an arbitrary power of employers to set wages at minimum subsistence. Wages at minimum subsistence was held to be the result of population growth, which, to feed the larger number of people, would require resort to the cultivation of progressively inferior lands and the more intensive cultivation of lands already under cultivation, either of which would result in a falling output of agricultural commodities relative to the number of workers. The same was held to be true in mining. This was held to reduce the buying power of wages as population increased and would go on until real wages were so low that workers could not afford to raise more children than were sufficient to prevent depopulation. This belief was descriptive of events prior to the nineteenth century, and from the perspective of the early nineteenth century appeared to be proved by economic history. Even so, Ricardo, the greatest of the classical economists could observe in 1821 that the operation of this “law” could be counteracted by continued capital accumulation. (David Ricardo, Principles of Political Economy and Taxation, 3d ed. (London, 1821), chap. V.)
- 2. The convention in economics is to talk of supply and demand “curves” and to refer even to straight lines as “curves.”
- 3. See Eugen von Böhm-Bawerk, Capital and Interest, 3 vols., trans. George D. Huncke and Hans F. Sennholz (South Holland,Ill.: Libertarian Press, 1959), 2:245. See also Capitalism, pp. 162–163
- 4. See Capitalism, p. 204.
- 5. See ibid., p. 59 and pp. 63–70.
- 6. Full employment, it should be realized, is consistent with many workers voluntarily choosing to remain unemployed while they search for particular job opportunities. In addition, full employment need not mean full employment throughout the economic system. The principle applies occupation by occupation, location by location. Thus, for example, the wage rates of house painters in Indianapolis cannot fall below the point of full employment of house painters in Indianapolis, irrespective of the state of employment in other locations or occupations.