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toomuchcoffee911's avatar

What's a good way of understanding the Iron Law of Wages?

Asked by toomuchcoffee911 (6928points) October 18th, 2009

Don’t worry, this isn’t a homework question. I know it was invented by David Ricardo during the Industrial Revolution. I’m just wondering what it is. I’ve Googled it, but I still don’t completely understand it.

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5 Answers

aeschylus's avatar

The short answer is that the law states: There is a minimum wage that workers can be paid and still do the work they need to do. This is called the subsistence wage. Over time, competition among workers for employment will bring wages down to this subsistence wage.

I understand it best if I try to think in terms of variables in an equation, or set conditions and things that result from those set conditions if one of them is allowed to change. This also makes it possible to expose certain assumptions underlying the “law.”

In such terms as those I would give an account like this:

There are 2 variables that interest us.
1. Number of workers, that is, population. This is also how the supply of labour is measured.
2. Wages, the amount each worker receives for one unit of labour, for instance, dollars per hour. In the long run, this is also how demand for labour is measured, but it is not the same as demand for labor.

Depending on what assumptions we take, these variables are related in different ways,
there are kind of three versions of the law depending on what assumptions you take as given. The first two interpretations assume a principle known as Malthus’ Demographic Principle, which states that as wages increase, so does population. Malthus furthermore posited that there was some amount workers could be paid that would prevent population growth altogether. This number he called the Subsistence Wage. All interpretations deal with understanding these two principles in terms of the supply and demand of labor. Thus, we get a third variable: demand for labor, or how much of a worker’s labor, or even how many workers, the existing economy needs to function. Price (wages) affects demand, while the price is also set by demand. Taking this as a given, we end up with one of two of the following possible interpretations.

1. Expounded by Ferdinand Lassalle in the mid-nineteenth century, the first interpretation states that: If we allow real wages to determine the demand for labor, then, as wages go up, the demand will go down, and in the long run the population will equal the number of people (allowed by malthus’ principle) that would be demanded at that wage. In other words, as wages increase, there are more people to supply the demand for labor (malthus’ principle), and so, since supply has increased, the wages will decrease. Since wages decrease, then population will also decrease, reducing supply and thus raising the price or wages of labor, and the population will grow. This back and forth oscillation will over time even out in a constant population of workers who all earn the subsistence wage.

2. Ricardo saw the absurdity in this because there were other factors affecting the demand for labor than just the price of labor. Specifically, demand is influenced by investment. Investment usually mean new things are found to be done or existing things can be done better, so demand for labor will increase as these new companies have litterally created more things to do for laborers. Therefore, wages can continue to increase and stay above the subsistence level as long as the growth the demand for labor increases faster than the population. However, Ricardo still held fast to Malthus’ principle that population increased with wages, but concluded that Lassalle’s prediction would never come true because demand would grow even if wages increased, to a certain extent. It is this insight of Ricardo’s that accounts for most of the increasing wages over the last two centuries, because continuous, monotonic economic growth has allowed an increase in population to coincide with an increase in real wages.

Finally there is a third principle based on a new view of Malthus’ Principle brought to light by historical data.

3. The current interpretation holds that the whole thing is bogus because malthus’ principle is false, at least in the 20th and 21st century. Historical data shows that the higher paid people are, the fewer children they have, and thus malthus’ principle is in fact opposite of the truth. It is unknown whether this tendency of people with more money to have fewer children (called demographic transition) is a universal economic law or the result of sociological aspects of modern societies and urbanisation. But for the moment it seems to hold true, even in the developing world, where people who move to cities have fewer children. In general, in agriculture, children are an asset, while in cities, where living space is limited and expensive and people have to have a significant amount of a specific kind of education before they can produce anything, children are a liability.

To summarize, the iron law of wages is a hypothetical relationship between the demand for labor and the population that affects the value of real wages. Given malthus’ Principle, the iron law holds that population and wages will fall until they match those determined by the demand for labor, which will minimize the cost of labor to the subsistence wage. It is false because economic growth affects the demand for labor, and because malthus’ principle does not seem to be true.

I hope this was helpful; let me know what you think, or if you have any questions.

toomuchcoffee911's avatar

Thank you! Just one question- how does competition among workers bring wages down?

aeschylus's avatar

The line of thinking assumes that all labourers are essentially the same, so we don’t have to worry about employers paying more for better workers. Thus, if there are fewer jobs than people (which, according to malthus’ principle there will be unless the subsistence wage is already reached), workers can only get a leg up over their competition by charging less for their labour. Thus, wages go down. This process will continue until workers can no longer afford to make any less than the subsistence wage.

toomuchcoffee911's avatar

Ohhh. Thank you very much.

bea2345's avatar

Of course, in actual practice, especially in countries which have a safety net such as unemployment insurance, employers cannot legally reduce wages below a certain threshold.

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