Wage fund Theory of Wages - Adam Smith (1776) & J.S. Mill (1848)

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 Wage fund Theory of Wages - Adam Smith (1776) & J.S. Mill (1848)

Introduction:

The Wage Fund Theory of Wages is a concept from early economic theory that seeks to show that the amount of money a worker earns in wages, paid to them from a fixed amount of funds available to employers each year (capital), is determined by the relationship of wages and capital to any changes in population. The theory was developed by Adam Smith and later developed by J. S. Mill. According to this theory, there is a wage fund in every country. This fund is of a fixed size. The wages to the workers are paid out of this fund. The average wage can be calculated by dividing the wage fund by the number of workers.

The wage-fund theory held that wages depended on the relative amounts of capital available for the payment of workers and the size of the labour force. Wages increase only with an increase in capital or a decrease in the number of workers. Although the size of the wage fund could change over time, at any given moment it was fixed. Thus, legislation to raise wages would be unsuccessful, since there was only a fixed fund to draw on.

Wage Fund Model:

At the core of Mill's Wage Fund Theory is the concept of a "wage fund." This wage fund is essentially the aggregate pool of capital set aside by employers to pay their workers' wages. It represents the total amount available for wage payments in an economy.

In essence, wage–fund doctrine states that workers' wages are determined by a ratio of capital to the population of available workers.

In this model, there is a fixed amount of capital available to pay for the costs of production and the wages necessary to sustain workers in the time between the start of production and the sale of production output. Capital may change from year to year, but only as a result of reinvesting the prior year's savings.

Population is the endogenous variable affecting wages. As the working population changes, the available wage moves in the opposite direction. Additionally, because capital is fixed, "the whole of [wage fund] is distributed without loss; and the average amount received by each laborer is, therefore, precisely determined by the ratio existing between the wage-fund and the number of laborers". If one worker earns more, another worker must earn less to compensate.

Wage Fund Determination:

According to Mill's Wage Fund Theory, the size of the wage fund is determined by various factors:

1. Savings and Accumulation: The extent to which employers save and accumulate capital affects the size of the wage fund. Higher savings contribute to a larger fund available for wages.

2. Demand for Labor: The demand for labor in the economy plays a crucial role in determining the size of the wage fund. When businesses expand and require more labor, the wage fund tends to increase.

3. Population Growth: Mill recognized that population growth could impact the wage fund. If population growth outpaces capital accumulation and demand for labor, it can lead to downward pressure on wages.

Critiques and Limitations:

1. Fixed Wage Fund Assumption: Critics argued that the assumption of a fixed wage fund was unrealistic. The size of the fund is not necessarily fixed but can change due to factors such as investment, economic growth, and capital accumulation.

2. Does not Account for Labor Productivity: The theory does not consider variations in labor productivity. In reality, workers with higher skills and productivity levels often earn more than those with lower productivity.

3. Neglects Collective Bargaining: The Wage Fund Theory does not account for the role of collective bargaining and labor unions in wage determination. In practice, labor negotiations can influence wage levels independently of the size of the wage fund.

4. Ignores Non-Market Factors: The theory primarily focuses on market forces and capital accumulation, neglecting non-market factors like government policies and regulations that can influence wage levels.

5. Long-Term Rigidity: The theory's assumption of a fixed wage fund is rigid in the long term. Economic conditions, technological advancements, and other factors can lead to changes in the size and distribution of the fund.

Conclusion

The Wage Fund Theory explains wages as being determined by a fixed wage fund and the size of the labour force, emphasizing the role of capital accumulation in wage determination. Although its assumption of a fixed wage fund is unrealistic in modern economies, the theory remains historically significant in the development of classical wage theory.

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