Theories of Wages 2 (Unit 1)

 Demand and Supply Theory

According to Marshall, the determination of wages is affected by the whole set of factors which govern demand for and supply of labour. It is therefore necessary to understand the various factors, which influence the demand for and supply of labour. The employers' demand for labour is dependent on a number of factors such as the demand for his/her product, availability of other factors of production (the most important being the supply of capital), the level of technological progress, etc. The demand price of labour is determined by the marginal productivity of worker.

Supply of labour can be viewed in a number of ways. 

First, it may refer to the number of workers seeking employment. This number will vary not only with the total population, but also with the proportion of the population, which is proletarianized. These are the workers with no alternative livelihood who join the labour market seeking employment for wages. 

Secondly, it may be the number of hours for which each worker is available for work. The supply of labour in this sense increase, by an increase in the number of working hours. 

Finally, the supply of labour varies with the intensity of work as the supply of labour tends to increase if the workers work harder than before.

As regards the relationship between wages and supply of labour it appears that higher the wages, greater will be the inducement to work and therefore the greater the supply of labour would be and vice versa. However, it may not always be true. Generally, supply of labour tends to increase with an increase in the wage rate. However, once the wage rate has reached a certain level, any further increase may not induce workers to work more. This is because with a rise in wages, workers may prefer leisure to work.

Therefore, wage rates are influenced by a number of factors governing the demand for and supply of labour. The marginal productivity of labour, which determines its demand price. It is the standard of living of workers that plays an important role in the determination of supply price of labour. The actual wage rate is determined at that level where the demand for and supply of labour are equal to each other. In real world, however, labour markets are generally non-competitive. The wage levels expected to result from the free interaction of demand and supply are often modified by the resistance from workers to accept wages below the subsistence level; trade union action, government intervention in wage fixation, and workers’ immobility.

 

Purchasing Power Theory

Classical economists, especially Pigou argued that a cut in wages during unemployment and depression would help restoring full employment in the economy. Lord Keynes in his ‘General Theory of Employment, Interest and Money' has criticized this classical viewpoint. Keynes looked at the problem of wage rates from a macro viewpoint. According to him, wage is not only the cost of production to the employer but also an income for the wage earners who constitute a majority in the total working population. The same workers and their families consume a major part of the products of the industry. Hence, if the wage rates are high they will have more purchasing power, which would increase the aggregate demand for goods and also a high level of output. Conversely, if the wage rates were low, their purchasing power would be less, which would bring about a fall in the aggregate demand. This will have an adverse effect on the levels of employment and output. Therefore, a cut in wage rate, according to Keynes, instead of removing unemployment and depression (as envisaged by the neo-classical economists) will further add to the problem. According to the Keynesian Theory, full employment is a function of national income; the higher the level of national income the greater the volume of employment and both income and employment are determined by effective demand. Hence, if the national income falls, it would have an adverse effect on employment.

In order to ensure incomes to wage earners and to restore full employment Keynes recommended state intervention by adopting economic policies such as monetary and fiscal policies. The other mechanisms, according to Keynes, could be direct controls over prices, wages, investment and production.

Comparative Advantage Theory

Economists specializing in international trade argued that countries, industries and companies compete on the basis of comparative advantage of cheap labour. Employers are known to move to areas where labour is cheap, be it within a country or across countries. Subject to internal and external constraints, labour also tends to show a tendency to move to areas, which pay higher value for their skills and effort. Besides land-labour nexus and other social, cultural, religious, linguistic, politico- legal barriers restricts labour mobility. Even the World Trade Organisation (WTO) agreement provides more for mobility of capital and products, but not labour force.

In recent years, however, there is pressure on countries and companies competing on the basis of cheap labour to ensure compliance with minimum core labour standards concerning minimum wage, freedom of association, right to collective bargaining, forced labour and non-discrimination. Efforts to link international trade with international labour standards at the international level and consumer boycotts and social labeling at the micro level through campaigns and other initiatives at the sectoral level make it increasingly difficult to compete on the basis of cheap labour if it violates core labour standards.

 

Limitations of Economic Theories

The economic theories are generally based on some assumptions. If those assumptions don’t hold good, the theory may not apply in specific situations.

a)        Economic theories either assume that wages and prices are either fully fixed (Keynesian paradigm) or fully flexible (neo-classical liberalists). The reality lies somewhere in between.

b)       Most wage theories are based on the assumption of full employment. In most developing countries this is not really the case.

c)        Labour is not as mobile as capital and products are. Therefore, wage rates could be influenced by the changes in the demand for and supply of factors other than labour too.

       In several industries labour costs are less critical than other costs. Also, fluctuations in interest rate and exchange rates as well as relative intensity of capital and technology influence the demand for, and may cause the substitution of, both the input of and the output of labour as well as the proportionate costs of labour in the total cost of production.

d)       Wages and benefits reflect industry characteristics and personal characteristics (including skill differentials) as well as societal preferences and prejudices.

e)        Interference by government and trade unions could minimize the influence of the market forces of demand and supply of labour.

f)         Technology and productivity are major determinants. Low wages may not mean low wage costs. Similarly high wage rates may not mean high unit labour costs.

g)       With growing pressure for linking labour standards with international trade, increasingly it will become difficult (for countries, industries and companies) to compete on the basis of comparative advantage of cheap labour.

 

 

 

           BEHAVIOURAL THEORIES AND RELEVANT ISSUES

  

Behavioural Theories

Every reward or element or compensation/remuneration has a behavioural objective and seeks to fulfil a need (physiological or psychological) and achieve a goal. Luthans argues that motivation is a process that starts with a physiological or psychological deficiency or need that activates a behaviour or a drive that is aimed at a goal.

Reward systems are aimed at compensating people for their skill, effort, responsibility and working conditions and motivating them for higher performance. Behavioural science theories are classified into three categories, content, process, and contemporary theories. These are discussed here very briefly.

Content Theories

The content theories look at what motivates people at work. Maslow, Herzberg and Alderfer contributed significantly to content theories. These are very briefly outlined here:

Hierarchy of Needs: Abraham Maslow proposed a hierarchy of five needs: physiological (food, shelter, clothing which wages can buy), safety (emotional and physical safety - health insurance, pension), love (affection and affiliation - belongingness, social), esteem (power, achievement, status, etc.), and self- actualisation (personal growth, realization of potential). Individuals may seek fulfillment of higher order needs before their lower order needs are fulfilled. Maslow suggests that a satisfied need is not a motivator. The exception, however, is the need for self- actualisation whose gratification increases in growth-motivated individuals.

Two Factor Theory of Motivation: Two-factor theory of motivation by Friedrich Herzberg classifies rewards into two categories: intrinsic and extrinsic. These are also called as motivators (satisfiers) and hygiene factors (dissatisfiers). Intrinsic rewards are motivators and satisfiers related to job content. They include achievement, recognition, work itself, responsibility, job enrichment, and job enlargement. Extrinsic rewards are hygiene factors and job dissatisfiers. These include company policies and administration, supervision, salary, interpersonal relations, working conditions. Herzberg’s theory over simplifies the complexity of motivation. Pay can be dissatisfying if it is very low, but alternative sometimes it can also be more satisfying than the job. A poster in an executive's cabin reads thus: I like the pay, not the job!

ERG Theory: Clayton Alderfer formulated this theory based on three groups of needs: existence (survival or physical well-being), relatedness (interpersonal) and growth (personal development) (ERG) theory. These needs are a continuum, not necessarily in the same order, rather than a hierarchical or compartmentalized category. Based on a person's background and cultural environment, one set of needs may precede over others. The works of Maslow, Herzberg and Alderfer are referred to as content theories. They are useful but have limited implications for policy and practice. Herzberg’s theory, however, provides insights for job design.

 

Process Theories

Process theories look at the cognitive antecedents that go into motivation or effort, particularly the way they relate to one another. We examine very briefly the work of Vroom (on valence and expectancy) and Porter and Lawer (performance-satisfaction linkage) in this regard.

Expectancy Theory: Victor Vroom proposed expectancy theory based on the concepts of valence, expectancy and instrumentality. Valence refers to an individual's preference for a particular outcome. For instance, most older workers might value retrial benefits against fewer, if any, younger workers in today's knowledge industry, Younger, single (unmarried) workers with fewer family obligations have less or no need for benefits like children's education, health benefits, leave travel concession, etc. than older, married people with one or more children. A related phenomenon is salience which refers to whether the outcome (in this case it could be reward or compensation) is considered significant or not. For instance, if management offers something as an incentive to its employees, it may not produce the desired behaviour or impact if the latter consider it as insignificant or devoid of worth commensurate with the effort required for the same.

Instrumentality could mean that an individual would be motivated to give superior performance (first-level outcome) in anticipation (expectation) of promotion (second- level outcome).

Expectancies are mental and cognitive. Although the concept of expectancy seems to be the same as that of instrumentality, expectancy relates efforts to first-level outcomes while instrumentality relates to first-level outcomes and second-level outcomes. In other words, expectancy is the degree of probability that a particular action or effort will lead to particular first-level outcomes. Instrumentality refers to the degree of probability that first-level out comes will lead to a desired second-level outcome. Put simply, Motivation is a -function of valence and expectancy.

Vroom's concept can be interpreted thus: Individual gives company what it values, superior performance and expects, in return, promotion. Promotion is the instrumentality that management uses to obtain superior performance. Vroom provides insights into the conceptual determinants of motivation. Though he does not offer specific suggestions on what motivates, and his theory is based on the assumption that people are rational and logically calculating, real life situations may not be so idealistic. But, then, it could well be seen that in companies where promotions are not based on superior performance, promotion policy and its administration could well become demotivating factors for labour.

 

Equity And Attribution Theories

EQUITY: J. Stacy Adams, who proposed equity theory, argues that a major input into job performance and satisfaction is the degree of equity (or inequity) that people perceive in their work situation. Inequity occurs when a person perceives that the ratio of his or her outcomes to inputs and the ratio of a relevant other's outcomes to inputs are unequal.

People feel unhappy not only when they receive less than what they consider they deserve, but also when they receive more than what they consider they deserve.

When an employee receives more than what he/she considers is fair, they begin to wonder whether others too are receiving more than what they deserve. If it is indeed the case, the next question that comes to their mind is compared to what they are getting, whether others are receiving much more than what they deserve

Adam proposal can be represented as follows:

 

Person’s out comes	<	Other’s outcomes
Person’s inputs		Other’s inputs
Person’s out comes	<	Other’s out comes
Person’s inputs		Other’s inputs
Equity occurs when
Person’soutcomes Person’s inputs	=	Other’s outcomes Other’sinputs

Related Issues: Equitycan be internalor external. Internal equityrefers to the pay differential between and among the various skills and levels of responsibility. For instance, a skilled worker could get more than the unskilled worker. Whether a blue- collar worker should get less or more than the white collar depends not only on relative skill differentials and difficulties in working conditions, etc., but also on the demand and supply of those skills and the dominant occupational preferences of people in the society. (When in one engineering fabrication industry gas cutters (welders) were getting less than grass cutters (gardeners) it was perceived by the technical staff that it was a glaring instance of a lack of internal equity because in that industry welding is considered to be a highly rated technical trade and should command higher wage rate). Internal equity is established through job evaluation. Pay satisfaction surveys also provide insights into it. Job evaluation can be done not only for manual jobs, but also for managerial jobs. Collective bargaining pressures have, however, substantially eroded pay differentials based on skill differentials. In many industries, dearness allowance and other employee benefits constitute bulk of the pay packet and basic pay, which is supposed to be based on job, evaluation constitutes only a small portion of the total pay packet.

 

External equity refers to concerns how wage/pay levels for similar skill levels in one firm compare with those in other firms in similar or same industry and location/region. For instance, if welders in one firm get the same as welders in the other firms in the industry/ region there is perceived external equity. External equity is assessed usually through pay surveys and pay satisfaction surveys. Companies, which pay significantly less than the market rates,would find it difficult to attract, retain and motivate people to perform better. Therefore, it is possible that low wage rates may not always be associated with low wage costs.

Non-discrimination should be an important consideration in pay policies. International Labour Organization (ILO) Convention No.100 concerns equal remuneration for work of equal value.For similar skill, effort, responsibility and working conditions pay should be similar. It is difficult to translate this principle into action because in reality pay differentials are based not onlyon these four factors but also on the demand for and supply of labour with relevant skills, the relative power of trade unions in collective bargaining which varies widely across sectors/industries and regions, the capacity to payof the firm/industryand the employer policies concerning pay on whether to lead or lag the average pay trends, in the industry/location.

Alfred Marshal's iron laws of wages suggest that the relative power of unions is dependent on four factors: (a) the substitutability of the input of labour, (b) the substitutability of the output of labour, (c) the proportionate cost of labour, and (d) the cumulative impact of the preceding three factors. As a result, for instance, the textiles workers power to obtain higher wages could be less than that of, say, airline pilots.

In India, the principle of equal remuneration is upheld, partly through Equal Remuneration Act, 1976. The legislation is aimed at ending discrimination in remuneration based on sex. The legislation affords protection against discrimination for women workers who are covered by the definition of workmen under the Industrial Disputes Act, 1947. Numerous judgments by courts limited the application of the concept of non-discrimination only to men and women doing similar work with similar qualifications in the same organization.

Attribution: Fritz Heider and Lewin and Festinger contributed significantly to the attribution theory. It assumes that people are rational and logical in their behaviour and that both internal and external forces combine additively to determine behaviour. People will behave differently if they realize that their outcomes are controlled internally more than externally. This theory has great potential for understanding, organizational behavior and provides deep insights on goal setting, leadership behaviour and diagnosing causal factors of employee performance.

 

IMPLICATIONS FOR COMPANY POLICY

Therefore, companies need to review not only how much they spend on their employees’ salaries and benefits but also how they are actually spending it on various items. If they ask their employees how they wish ‘X’ amount to be distributed across various items and compare how the company is actually spending, variations, if any, between the actual spending by the company and employees preferences on how they wish the amount to be distributed will give insights on how companies could maximize pay satisfaction without increasing the expenditure or cost to the company on account of employees pay and benefits. This is one of the reasons why several private sector organizations have conceived and operationalized cafeteria type benefit programmes for their employees, particularly in executive cadres. A fixed ‘thali’ type menu means employees have no option to choose and some may be forced to leave many items because they could not avail them due to their personal and family circumstances and preferences. In contrast, ala Carte or cafeteria method enables employee to choose items of their choice within a certain range of amount to which they become eligible.