The Structure and Determinants of Wage Relativities

Evidence from Australia

Alison Preston

• Publisher: Routledge
• Year: 2018
• ISBN:
  9781351783125
• Edition: 1
• Topic: Business
• Subtopic: Business General
• Index: Business

This title was first published in 2001. Drawing on the fields of labour economics and industrial relations, this book simultaneously applies human capital theory and institutional analysis to an explanation of occupational and other wage differentials. This outstanding study contains a wealth of reference material on both the economic and normative determinants of wages. Destined to become a landmark study in the area of Australian wage determination, the book is an essential text for labour economists, industrial relations specialists, researchers and policy makers alike.

1 Reflections on Wage Theory

Introduction

There is a voluminous literature on the theory of wages, some of which dates back to the eighteenth century. There remains, however, much debate as to the determinants of wages. Progress in this field has been hampered, in part, by the increasing separation of two important research fields – industrial relations and labour economics. Both disciplines have much to say about the theory of wages although each approaches the issue from a different perspective and each holds vastly differing opinions as to the key determinants. Labour economists, for example, emphasise supply side determinants such as education, training and experience. Industrial relations researchers focus on demand side determinants such as unions and wage fixing institutions. Each discipline also differs in the methodological approaches used to examine the determinants. Economists typically favour quantitative techniques. In industrial relations the emphasis is on qualitative case-study approaches. The separation of the disciplines means that it is quite common to find industrial relations experts with limited knowledge of economics and labour economists with no knowledge of industrial relations. Wages policy requires a full understanding of all the determinants to be effective.

From a policy perspective the reintegration of these two disciplines is, therefore, a crucial task. Policies which may make good economic sense are not necessarily optimal from an industrial relations perspective, and vis a vis. For example, freezing the wages of the low paid may bring about desirable employment effects but may have adverse effects on morale, motivation and productivity levels if the low wage workers perceive that, relative to others, their rates of pay are ‘unfair’. Workers assess whether or not they are being fairly paid by reference to the rates around them (Brown and Sisson, 1975).

This book endeavours to provide one bridge across the discipline-gulf described above. In setting the scene the remainder of this chapter provides a brief overview of the history of wage theory illustrating the various developments and then subsequent divergence in the industrial relations and economic disciplines.

Developments in Wage Theory¹

Adam Smith was amongst the first to write on the theory of wages. In his treatise, The Wealth of Nations, Smith set out what he considered to be the main determinants of wages. First and foremost he regarded wages not simply as a payment for services provided, but as a means of survival.

A man must always live by his work, and his wages must at least be sufficient to maintain him. They must even upon most occasions be somewhat more; otherwise it would be impossible for him to bring up a family, and the race of such workmen could not last beyond the first generation (Smith, 1957, p. 60).

This subsistence theory of wages was subsequently echoed by David Ricardo who defined the price of labour as ‘… that price which is necessary to enable the labourers, one with another, to subsist and to perpetuate their race, without either increase or diminution’ (Ricardo, 1971, p. 52). The subsistence theory of wages was a long-run theory. If the wage rate rose above the subsistence level families would propagate, the labour supply would increase and, in the long-run, push the wage rate back down to the subsistence level.²

Smith did not discount the role of competition in determining the wages paid. Rather, he regarded the rate as being ‘… regulated by two circumstances; the demand for labour, and the price of the necessaries and conveniences of life’ (Smith, 1957, p.76).³ The competitive environment he observed was, however, rarely one where there was ‘competition among masters’ or where workers and masters had equal bargaining power. Instead bargaining usually took place between a ‘combination’ of employers and workers, with the former having the ‘advantage in the dispute’:

What are the common wages of labour, depends everywhere upon the contract usually made between those two parties, whose interests are by no means the same. The workmen desire to get as much, the masters to give as little as possible. The former are disposed to combine in order to raise, the latter in order to lower the wages of labour.

It is not, however, difficult to foresee which of the two parties must, upon all ordinary occasions, have the advantage in the dispute, and force the other into a compliance with their terms. The master’s being fewer in number, can combine much more easily; … In all such disputes the masters can hold out much longer In the long-run the workman may be as necessary to this master as his master is to him; but the necessity is not so immediate (Smith, 1957, pp. 58–9).

The wages-fund doctrine subsequently replaced the subsistence theory. Unlike subsistence theory, under the wages-fund doctrine it was recognised by Ricardo that wages might rise above the subsistence level for ‘an indefinite period in an improving society’ (Dobb, 1952). It was believed that there was a finite pool of wages for distribution to all workers. The wage level was thus arrived at by dividing the wage-fund (or wage pool) by the size of the workforce. Proponents of the theory used it to argue that higher wages would deplete the fund and place restrictions on the awards given to other workers. In other words, it would rob them of their entitlements.

In 1890 Alfred Marshall fundamentally altered the focus of wage theory when he published the first edition of his book Principles of Economics. In it he argued that wages were determined like any other good – by the market forces of supply and demand.

The normal value of everything whether it be a particular kind of labour or capital or anything else, rests, like the keystone of an arch, balanced in equilibrium between the contending pressures of its two opposing sides; the forces of demand press on one side, and those of supply on the other (Marshall, 1961, p. 526).

A feature of Marshall’s marginal productivity theory was that he was able to demonstrate, with the use of mathematics, the link between marginal utility and marginal productivity in the determination of wages. An important assumption invoked was the (near) perfectness of the labour market; a situation he envisaged as prevailing in the long-run.

Although often forgotten, Marshall, like his predecessors, was also aware of the social character of wages and acknowledged that labour was different from other factors of production. ‘The first point to which we have to direct our attention is the fact that human agents of production are not bought and sold as machinery and other material agents of production are’ (ibid., p. 466). On the ‘peculiarities’ of labour he cites: the immobility of labour, the fact that skills are ‘perishable’, and the weak bargaining power of the unskilled (pp. 471–3).

By the turn of the twentieth century Marshall’s marginal productivity theory dominated economic thinking on wages. It swamped the contribution of others – the Webbs, Pigou and Rowe – where the emphasis was much more on the social determinants of wages.

In their book, Industrial Democracy, first published in 1897, Sidney and Beatrice Webb highlighted the peculiarities of labour and argued for the imposition of a minimum wage to maximise social welfare. In their view the ‘higgling of the market’ was socially destructive. Employers had the advantage in the bargain, with unemployed workers undermining the bargaining power of the manual workers in particular.

In the Economics of Welfare, first published in 1920, Pigou similarly highlights the social character of wages, pointing out that factors such as ignorance, costs and ‘artificial restrictions’ such as custom and tradition, prevent labour from moving to different occupations and places as predicted by competitive wage theory. He notes, for example, that women are excluded from certain occupations (1960, p. 507). In other chapters Pigou deals with the process by which wages are typically determined, noting that where competition is not free wages are often bargained by employer and employee representatives and that there is a range of indeterminateness within which the ‘higgling and bargaining’ will be conducted (ibid., p. 452). This contrasts with the competitive model where ‘the wage rate paid by any employer in any occupation would be determinate at a definite point’ (p. 557).

Pigou also deals at length with the issue of fair wages, noting that there are ‘two principal sorts of unfair wages’: firstly wages may be unfair if the rate paid is less than the value of the marginal net product (i.e. where there is exploitation); secondly wages may be unfair if they are not equal to the wages of similar labour elsewhere (as in the case of male and female wages). In his subsequent discussion of fair wages he, like his predecessors, also argues that wages should be sufficient to provide for a family’s needs. They ought to:

yield a decent subsistence to the average worker: a ‘decent subsistence’ for the average man and the average woman respectively being interpreted in the light of the fact that the former has, and the latter has not, to support a family (Pigou, 1960, p. 597).

In Rowe’s book, Wages in Practice and Theory, published in 1928, attention is similarly placed on ‘real world’ observations of the wage structure. Rowe studies wage movements in five industries – building, coal-mining, cotton manufacturing, engineering and the railway service – and concludes from this that the process of wage determination varies considerably across industries. He is thus led to question ‘… in fact whether there can be one all-embracing theory of wages, which will sufficiently satisfy our sense of reality, and stand the test of historical experience’ (Rowe, 1969, p. 192). In his ‘reconsideration of wage theory’ trade unions are identified as one dominant force which has had important effects on the structure of wages. He thus concludes that:

any theory which minimises the influence of modern collective bargaining, or disregards it, must justify such procedure by abundant and conclusive evidence. Commonsense and a priori reasoning make it well nigh impossible to suppose that the development of collective bargaining has had no effect of any kind on the general level and the structure of wages (ibid., p. 195).

In Britain social wage theory gained growing acceptance in the 1930s. In 1933, for example, Joan Robinson published her book The Economics of Imperfect Competition. In 1936 John Maynard Keynes published The General Theory. Both authors shared the common view that the market for labour was far from perfect. As with earlier writers their theories were premised on real world observations.

Keynes, for example, observed that workers were more concerned about their money wages rather than their real wages. Moreover, money wages were downwardly rigid. This downward inflexibility of money wages he attributed to workers concerns regarding wage relativities. Changes in the price level would affect the real wage of all workers simultaneously. However, unless nationally agreed upon, a decision to adjust the money wage (downwardly) would typically occur industry by industry (for example). Thus relativities would be disrupted in the process and there was always the danger that others would not agree to the wage cut (thus explaining the reluctance to be the first to agree to a cut in money wages).

The only dissident at this time appeared to be John Hicks who, in contrast to the others, continued to defend competitive wage theory. He acknowledged that with the growth of trade unions and the growth in wage regulation the landscape had changed since Marshall first developed marginal productivity theory. However, he maintained that The same forces which determine wages in a free market are still present under regulation; they only work rather differently’ (Hicks, 1973, p. x). By the mid-1930s Hicks’ own belief in competitive wage theory had, however, began to waver (Hicks, 1973, p. 307) and he subsequently came to acknowledge that both economic and social forces were combining to influence wages.

Social wage theory was slower to gain acceptance in America than in Britain. In 1934 Paul Douglas also published a book entitled The Theory of Wages in which he, like Hicks, presented a neoclassical treatment of wages. The main difference between Douglas and Hicks was that the former regarded labour markets as imperfectly competitive and perceived unions and regulatory frameworks as having beneficial effects.

In the post-war period a number of other American economists gradually challenged the classical position on wages; notably Lester (1946 and 1948), Reynolds (1948), Ross (1948), Kerr (1950 and 1954) and Dunlop (1957). Known by some as neoclassical revisionists (or sometimes neo-institutionalists), this group attempted to redefine theory so that it more accurately described the world it purported to represent (Kerr, 1994). They were linked by a common appreciation of the role of institutions in shaping wage outcomes.

In 1954 Clark Kerr published a seminal article The Balkinization of Labor Markets wherein he discussed the character and rules (formal and informal) of ‘the institutional labour market’. His principal argument was that institutional labour markets create non-competing groups comprising of insiders and outsiders. The idea of internal labour markets advanced by Kerr was later expanded upon by Dunlop (1957).

The defining contribution of Dunlop was the characterisation of the wage structure as comprising of ‘job clusters’ and ‘wage contours’. He defined the former as a group with common wage-making characteristics (e.g. technology, administrative organisation or social customs). In the labour market these job clusters were linked to other job clusters via a number of mechanisms (e.g. product markets, skills or unions) and their wages joined to form a ‘wage contour’. Dunlop’s conceptualisation of job clusters and wage contours provided a basis for explaining, and understanding, the role of key rates and spill-over forces (wage flow-ons) in the labour market (Dunlop, 1957, pp. 129–33). The principal force was that of fairness or equitable comparisons.

Dunlop’s attempt to refocus wage theory was swamped by a revival of neoclassical thinking on wages. Led by George Stigler and Milton Friedman, competitive wage theory gradually made a come back. Both writers were adamant that competitive theory was capable of making realistic predictions on labour market outcomes, even if the assumptions underlying the model were an abstraction from reality...

Table of contents

• Cover
• Half Title
• Dedication
• Title Page
• Copyright Page
• Table of Contents
• List of Figures
• List of Tables
• List of Cases Cited
• List of Abbreviations and Acronyms
• Acknowledgments
• 1 Reflections on Wage Theory
• 2 Human Capital Model: A Theoretical Overview
• 3 Wages in Practice: Wage Fixing in Australia
• 4 Human Capital and Earnings: A Review of the Literature
• 5 Determinants of Male Relative Earnings
• 6 Determinants of Female Relative Earnings
• 7 Equitable Comparisons and Spillover Forces in Wage Determination
• 8 Summary and Conclusion
• Bibliography
• Appendices
• Index