The General Level of Wages

John Tippet

[Reprinted from Progress, July/August 1998]

Editor's note:

This examination of how the general level of earnings in the community is determined is, at times, challenging. It would, however, well repay the time taken to understand it.

Background theory

In a free-market (capitalist) economy, the general level of earnings is set by employment opportunities at the margin.

A man will only work for any employer on terms that are at least as good as the man's best alternative employment, and at the margin this alternative is to work for himself. If the necessary site (be it office, factory, farm) is available free of charge, then the man's "earnings" will be the net value of production from that site. If all sites are privately owned, as is invariably the case in a free-market economy, any would-be occupant has either to come to terms with the owner and meet an agreed rental payment, or purchase the site outright. For most, the latter alternative is financially impossible, and so the former, that is rental from the landlord, is the viable alternative.

Since land (a "site") is the first necessary condition of any economic activity, where all sites are privately owned then rental asked by landlords will be at or near the maximum the market can bear. For any one site this will be that amount that leaves the tenant (our man seeking alternative employment) just enough to meet his costs of production and some minimum acceptable return for his efforts. If this "return" be analysed as made up of two components, "earnings" (or wages) and profit, then both these components will be at a minimum, that minimum below which a man would not accept. The rental asked by landlords where all land is fully enclosed will rise to ensure that wages (and profits) are at a minimum. Earnings (or profits) above this minimum would be a short-run phenomenon only.

It is this minimum level of earnings at the margin that sets the general level of earnings for the whole economy. The actual "minimum" determined will be the outcome of two bargaining factions:

1. the landlords (in setting the level of rent); and
2. employees (via their union).

This establishment of a minimum level of earnings can be shown diagrammatically as follows, where it is assumed that initially the total stock of land of the economy is freely available for occupancy and that occupancy, and hence ownership, is a function of growth in population.

When population is small and a correspondingly small proportion of the economy's available sites are occupied, the margin of "cultivation" will have reached only point a, and site productivity will be relatively high at Oa', (assuming that the best sites are occupied first). The full production Oa' of the site will be appropriated in transfer earnings, as "labour" (here defined as factors of production other than land) has ample opportunity if it is not paid Oa' to leave its employer and take up a site for itself, from which it could produce (and retain) Oa'. However, with growth in population and extension of the margin of "cultivation" to b, with less advantageous sites being occupied production per unit land area falls to b', and transfer earnings also fall from Oa' to Ob'. The difference a'b' now accrues to intra-marginal site holders as economic rent, and this rent capitalized gives all sites in the band Oa a price (a market value). The horizontal line b'B is the "rent line".

With further population growth and corresponding extension in the margin of "cultivation", and this extension presumably being upon sites of lower productive potential, the level of production at the margin falls, transfer earnings fall (these earnings being total production at the marginal site), and economic rent on intra-marginal sites rises. Eventually the last available unoccupied site will be claimed, transfer earnings (for all sites) will be Od', d'D will be the rent line, and the price of sites Oa will have progressively risen from zero to a'd' capitalised. Sites cd will earn zero economic rent, and accordingly will have a market value of zero. It has been assumed that the total land area, the total availability of "sites", of the economy is represented by the horizontal distance Od.

With occupancy (and assumed "enclosure", i.e. private ownership) of the last available site, comes the proposition that labour has no source of employment but that offered by existing site occupiers. The general level of earnings for the whole community will be determined by earnings on the marginal site, and so will be a maximum of Od'. Now since employees have no alternative they must accept that the landlord on the marginal site is likely to bid down earnings to some level below Od', such as Oe. Just how far below Od' will depend upon the bargaining strength of labour. (If the level of earnings were to be bid up by labour above Od', all sites in the interval cd, that is, all marginal sites, would be abandoned).

The proposition in terms of the outline

(a) Assuming constant technology and hence constant productivity, the bidding down of the general level of earnings to Oe (with eE being the "earnings line") has two effects:

• It (obviously) lowers the general level of earnings.
• Marginal sites assume some positive market value (equal to ed' capitalised) where previously this was zero.

There is thus postulated a relationship between the general level of earnings in a free market economy and the price of land. As ed' (equals DE) grows, the price of land will increase and the general level of earnings will decrease. (If technology is taken as a variable and productivity of the marginal site allowed to increase, earnings as a proportion of production will decrease).

(b) Labour theory has it that the level of employment will be up to the point where:

w = VMP

where: w represents the wage rate

VMP represents value of the marginal product

The above hypothesis (i.e. the postulated relationship between earnings and the price of land) is an attempt to explain w, in terms of the general level of earnings in the economy. For example, if the "general level of earnings" today is $350 per week, why is it not $700, or $200? Is there some fundamental principle that determines it?

Suggested areas of research (for interested Georgists)

(i) In terms of the above diagram ed' (equals DE) capitalised would be increase in the price of land not accounted for by gains in total productive ability of the land.

(ii) The "general level of earnings" could be viewed from two aspects: "average weekly earnings" over time, and earnings as a proportion of GDP.