Theory of Wages

Harry Gunnison Brown

[Reprinted from the Henry George News, September, 1956]

Most of us are aware of the law of diminishing returns. In order to discuss this law in connection with the problem of wages we shall use a very simple illustration. In studying geography the student is shown a globe. From this he may gain a general understanding of the world even though he cannot find on it such details as the creek which runs across his uncle's back yard. But surely it is an advantage for him to study the globe. For the purpose of this discussion we will assume that two factors of production, land and capital, will remain fixed or static. Further, that with three men working together 13,000 bushels, yards, tons of (say) wheat, corn or "widgets" can be produced yearly. If a fourth worker is added the output becomes 16,600 bushels. In other words, the fourth man has added to or increased the output, by 3,600 bushels. If a fifth worker is added the total output is 20,000 bushels, or the last worker adds 3,400 bushels. With a sixth worker the output becomes 23,200 bushels, or the sixth worker adds 3,200 bushels. When a seventh worker is added the output is 26,200 or the seventh worker adds 3,000 bushels. With eight workers the output becomes 29,000 or the eighth worker has added 2,800 bushels. Thus we can see the operation of the law of diminishing returns. While each additional worker makes possible a greater total product, the amount added by an extra worker is less when there are many workers employed than when there are fewer. The reason for such "diminishing returns" is that with more workers and no more land and capital for them to use, each worker is less well equipped or provided with these essentials for effective production.

Along with the productivity of labor-what is added by the worker -- we must consider the law of demand and supply. To state it simply, so long as the supply of workers exceeds the demand for workers, there will be a bidding for jobs. This means that unemployed workers will take jobs for a lower wage, thus bidding down wages. On the other hand, when the demand for workers at a certain wage, exceeds the supply of workers who are seeking jobs, then establishments must offer more to secure the workers. This tends to bid up the wage which must be paid.

To summarize what has been presented, wages tend to be fixed by demand and supply at the point where the wage is equal to the marginal product.

The marginal product in our illustration can be arrived at in this fashion. We shall assume that there are 675 workers in this community and 100 establishments which are seeking workers. The wage, as we have just seen, cannot be fixed at a point which would result in some workers being unemployed for they would accept work for lower wages (unless some well enforced law forbade hiring workers for less) and so bid down the wages. Neither can the wage be so low that the demand for workers far exceeds the supply of workers, thus bidding up the wage. If this point of equilibrium (where all workers are employed) is to be reached, many of the 100 establishments must take seven men. Since the seventh man adds 3,000 bushels of wheat (the worker's productivity) this is what will be the worker's wage. To translate it into terms of money, let's assume that the wheat sells for $1.00 per bushel. That would mean that the worker's wage would be $3,000 annually.

But you may be wondering why the wage in our illustration would be fixed at this point of 3,000 bushels or $3,000 per year. We have found that at this point all workers would be employed. It would be definitely worth-while adding the fourth, fifth, sixth worker, and the seventh worker could also be employed, for in each case the worker would add more than or, in any case, as much as it would be necessary to pay him. However, it would not be worthwhile to add the eighth worker for he would only add 2,800 which would be less than the wage he would have to be paid. You may well ask the question "But what about the seventh man, if he must be paid $3,000 and he only adds 3,000 bushels (or $3,000) ?" Some employers will decide to take the seventh worker (say 75 establishments) while for others (say 25 establishments) it does not seem worthwhile to add the seventh. This point of doubt -- whether to hire or not to hire -- is the margin. The product added by that worker is the marginal product. (In our illustration that was 3,000 bushels of wheat.) This would mean that those establishments -- 75, in our illustration -- on which it seemed worthwhile hiring seven workers, would pay each worker an annual wage of $3,000. For those establishments on which it did not seem worthwhile hiring more than six workers the wage would still be the same -- $3,000 annually. (If it will aid in understanding, the reader may assume that, on 75 of the establishments, the worker adds very slightly more than 3,000 bushels.)

Perhaps you have some objections such as these: Not all workers are equally efficient. Some workers are stronger, or more intelligent, or have been on that particular job much longer (seniority); thus are worth more because they produce more. Why, then, should all workers receive the same wage? True, in real life workers are not all alike. Workers who consistently produce more because of one or more of the reasons just noted, generally are aware of this fact and demand a higher wage. Their firms or companies are apt, also, to be aware of their superior efficiency and to pay them higher wages. Otherwise such workers may seek other jobs. This is a different situation than arises when we note that, in our illustration, the fourth man added 3,600 bushels of wheat, 3,400 bushels were added by the fifth man, the sixth man added 3,200 and the seventh added 3,000. If the fourth man, when no better than the others, were to quit, leaving only six men working, the total output would be reduced by only 3,000. That is all he is really worth. Of course in real life we cannot be so precise or know so definitely the exact amount added by each worker. All we can do is to use the best judgment we have in such matters. Certainly an employer is unlikely to hire a worker if he feels pretty sure that the amount of product added by that worker is worth less than the wages he must be paid. Wages depend on production, and workers' production is less when the capital and laud in proportion to workers is less. How could an employer pay current wages to his workers, if each of them had only a pointed stick to work with and a square foot of earth to work on?

Now to return to our point that the fourth, fifth, sixth, etc., worker -- assuming these workers to be equal in efficiency -- add a progressively decreasing amount to the total output, yet each worker will receive the same wage which is determined by the marginal worker (in our illustration the seventh worker. But you may say, the fourth worker added more than the seventh worker. Why must he receive the same wage? Does not the fourth worker add (or produce) more than the fifth worker? The crux of the matter is that with additional workers without additional capital and land in like proportion, there are diminishing returns. If the fourth worker feels he is not receiving a just wage, quits his job and goes to another, he may become the seventh worker at this latter establishment. And if he is one of seven, on the establishment where he is now working, his quitting would leave six workers and would reduce the total output by only 3,000 bushels. To the employer he is the seventh!

The total product in our example, with seven workers, was $26,200. The wages were $3,000 per worker, making total wages of the seven workers come to $21,000. The sum of $5,200 remains, therefore, as income ("interest") for those who have provided the capital used in production and as rent to owners of land and sites.

Now let's go back to the original number of workers in our illustration -- 675 workers and 100 establishments -- which resulted in seven men being hired by many establishments and a wage of $3,000 annually. Suppose a law which cannot be evaded sets the wage which must be paid at $3,400. This would mean that the firms could not afford to hire more than five workers apiece. Only 500 would be hired and 175 would be out of work. If any labor organization attempts to create such a situation, some workers might have a higher wage but many could not earn at all.

A somewhat similar situation arises if a labor group is permitted to limit the number of workers in a given line. Let us suppose, for example, that the number of workers able to learn a particular trade is thus limited. Then those who would go into that trade were it not for the limitation which prevented their doing so, must seek employment in other lines. Therefore, there are more workers in other lines; and because there are more workers in these other lines the wages in them are forced down. The results are better for workers in general if supply and demand in a free market are relied on instead of arbitrary wage fixing.

We have seen that wages are determined by the worker's productivity. It was also seen that this productivity of the worker diminishes with each additional worker ("diminishing returns"). Now let's consider what can be done to increase the worker's productivity and, consequently, his wages. Workers who are better supplied with tools and other means of effective production can produce more. Machinery and tools are classed as capital, along with fruit trees, cattle, ships, trucks, locomotives, etc. All of these are really tools and all are classed as capital. More and better capital increases the worker's productivity and thus strongly tends to increase wages.

Presumably a farmer can produce more wheat if he has a farm of 200 acres than if he has a farm of 30 acres. So we can see that more good land can also have an influence on what the worker (not alone the farm worker, but it is perhaps easier to see the influence there) can produce and, therefore, on the worker's wages.

Let us consider what can be done in our tax policy that will result for our workers in more and better tools and more good land. The tax system in the United States to which we are accustomed today, goes unnecessarily far in taking away from those who save and invest, the natural reward (in extra productivity of industry) of their saving. It does not do as much to promote saving and investing in capital as the best tax system could do. If our tax system draws too heavily on what capital yields, we may drift into socialism and compulsory saving as necessary in order to provide the capital equipment on which labor must depend.

Neither does our present system accomplish as much as the best system could do to force into use more good land. Our present system does little to discourage or penalize the holding of good land out of use. In the United States this is a very real problem when we consider that about a third or more of city and in America is held out of use. If instead of taxing capital as heavily as we do today, land (bare-land value not including any capital in the form of land improvements or other capital) were to bear most of the burden of taxation, the results would be far different than are secured by the system with which we are familiar. A system which taxes land values is a means of securing public revenue that does not lessen the incentive to save and invest in capital and does not burden the poor.

Such a system would be more favorable to capitalist incentive than any other system of taxation whatsoever. It would mean more effective use of our natural resources and our valuable city sites, so often held wastefully out of use. It could -- and would -- conduce to higher wages for workers. And this no other system of taxation would do or could possibly do. No system of labor organization and no policy of labor unions can possibly -- without creating substantial unemployment-raise the wages of workers to a higher level than the productivity of workers. Do our labor leaders - to whom the workers look for guidance-want to do the best possible for the rank and file workers who are their constituents? If so, they must cooperate -- better still, lead -- in securing the adoption of a tax system which will raise wages by increasing worker's productive power. To be able to do this effectively, they must gain an understanding of the cause and effect relations explained in this discussion.