Wage Theories

Economic theories of wages

1. Subsistence theory
The subsistence theory of wage is also known as “iron law” of wage. It was so named by
physiocrats like Lassalle, a German economist and Quesnay, a member of school of
economists and developed by David Ricardo. The theory of population, expounded by
Malthus was also based on this “iron law”. According to this theory, wages tend to remain at
the subsistence level. Wages paid to workers is just sufficient to fulfill their basic needs.
Workers don’t have surplus income.  If wages rises above this level, this leads to an increase
in the population because the increased prosperity of workers will encourage the workers to
marry sooner and increase population. This will increase labor supply.


Ignores the demand side of labor:
This theory is one-sided. It explains the wages from the supply side only. It
completely ignored the demand for labor. But if a rise in wages leads to an increase in
population, the larger supply of labor may be balanced by an increase in the demand
for labor.
 No direct relationship between wage level and population:
According to this theory, population increase if the workers are paid above the
subsistence level but empirical evidences show the decrease in population or its rater
of growth in developed nations even if there is increase in wage level. People spend
money on education, family planning, skill development too.
 Ignores trade unions:
This theory has ignored trade unions through which the workers make the collective
bargaining for their benefits.
 Notflexiblewagelevel:
Wages of all workers is at the subsistence level and is not flexible towards up and
down. However, wages can differ from occupation to occupation and from place to
place.
 Exploitative:
There is tendency toward exploitation in this theory. Because, according to the theory
wages must be equal to the subsistence level, and-not for comforts and luxuries.

2. Wage fund theory

This theory was developed by Adam Smith (1723-1790). His theory was based on the basic
assumption that workers are paid wages out of a pre-determined fund of wealth. This fund, he
called, wages fund created as a result of savings. According to Adam Smith, the demand for
labour and rate of wages depend on the size of the wages fund. Accordingly, if the wages
fund is large, wages would be high and vice versa.
3. Residual claimant theory
This theory owes its development to Francis A. Walker (1840-1897). According to Walker,
there are four factors of production or business activity, viz., land, labour, capital, and
entrepreneurship. He views that once all other three factors are rewarded what remains left is
paid as wages to workers. Thus, according to this theory, worker is the residual claimant.
4. Surplus value theory

This theory was developed by Karl Marx (1849-1883). This theory is based on the basic
assumption that like other article, labour is also an article which could be purchased on
payment of its price i e wages. This payment, according to Karl Marx, is at subsistence level
which is less than in proportion to time labour takes to produce items. The surplus, according
to him, goes to the owner. Karl Marx is well known for his advocation in the favour of
labour.
5. Marginal productivity theory

This theory was propounded by Phillips Henry Wick-steed (England) and John Bates Clark
of U.S.A. According to this theory, wages is determined based on the production contributed
by the last worker, i.e. marginal worker. His/her production is called ‘marginal production’.
6. Bargaining theory of wages

John Davidson was the propounder of this theory. According to this theory, the fixation of
wages depends on the bargaining power of workers/trade unions and of employers. If workers
are stronger in bargaining process, then wages tends to be high. In case, employer plays a
stronger role, then wages tends to be low.
7. Supply and demand theory

The law of supply and demand is a theory that explains the interaction between the sellers of
a resource and the buyers for that resource. The theory defines the relationship between the
price of a given good or product and the willingness of people to either buy or sell it.
Generally, as price increases, people are willing to supply more and demand less and vice
versa when the price falls.

 The law of demand says that at higher prices, buyers will demand less of an
economic good.
 The law of supply says that at higher prices, sellers will supply more of an economic
good.
 These two laws interact to determine the actual market prices and volume of goods
that are traded on a market.
 Several independent factors can affect the shape of market supply and demand,
influencing both the prices and quantities that we observe in markets

Behavioural theories / Motivational

1. Maslows need theory

Abraham Maslow’s motivation theory is based on the human needs. These needs are
classified into a sequential hierarchy from the lower to higher order as five need clusters
These needs are of the lowest-order and most basic needs of human
beings. These involve satisfying fundamental biological drives, such
as the need for food, air, water, cloth, and shelter generally
expressed in the names of roti, kapada aur makan. These needs
exert tremendous influence on human behaviour. Entrepreneur also
being a human being has to meet his physiological needs for
survival. Hence, he / she is motivated to work in the enterprise to
have economic rewards to meet his / her basic needs.

2. Safety and Security Needs:

The second level of need in Maslow’s hierarchy is emerged once
physiological needs are met. Safety needs involve the need for a
secure environment, free from threats of physical and psychological
harm. These needs find expression in such desires as economic
security and protection from physical dangers. Meeting these needs
requires more money and, hence, the entrepreneur is prompted to
work more in his/ her entrepreneurial pursuit. Like physical needs,
these become inactive once they are also satisfied.

3. Social Needs:
Man is social animal. These needs, therefore, refer to belongingness
or affiliation. All individuals want to be recognized and accepted by
others. Likewise, an entrepreneur is motivated to interact with
fellow entrepreneurs, his employees, and others.

4. Esteem Needs:
These needs refer to self-esteem and self-respect. These include
such needs that indicate self-confidence, achievement, competence,
knowledge, and independence. In case of entrepreneurs, the
ownership and self- control over enterprise satisfies their esteem
needs by providing them status, respect, reputation, and
independence.

5. Self-Actualization:
The final step under the need hierarchy model is the need for self-
actualization. This refers to self- fulfillment. The term ‘self-
actualization’ was coined by Kurt Goldstein and means to become
actualized in what one is potentially good. An entrepreneur may
achieve self-actualization in being a successful entrepreneur.

In Maslow’s above need hierarchy theory, human needs are

arranged in a lowest to the highest order. The second need does not
dominate unless the first is reasonably satisfied and the third need
does not dominate until the first two needs have been reasonably
satisfied. This process goes on till the last need.

This is because man is never satisfied. If one need is satisfied,

another need arises. Once a need is satisfied, it ceases to be a
motivating factor. For entrepreneurs, it is mainly social, esteem,
and self-actualization needs which motivate them to work more and
more for satisfying them.

2. Herzberg motivation theories

In 1959, Frederick Herzberg, a behavioural scientist proposed a two-factor theory or the

motivator-hygiene theory. According to Herzberg, there are some job factors that result in
satisfaction while there are other job factors that prevent dissatisfaction. According to
Herzberg, the opposite of “Satisfaction” is “No satisfaction” and the opposite of
“Dissatisfaction” is “No Dissatisfaction”.
 FIGURE: Herzberg’s view of satisfaction and dissatisfaction

Herzberg classified these job factors into two categories-

a. Hygiene factors- Hygiene factors are those job factors which are essential for
existence of motivation at workplace. These do not lead to positive satisfaction for
long-term. But if these factors are absent / if these factors are non-existant at
workplace, then they lead to dissatisfaction. In other words, hygiene factors are those
factors which when adequate/reasonable in a job, pacify the employees and do not
make them dissatisfied. These factors are extrinsic to work. Hygiene factors are also
called as dissatisfiers or maintenance factors as they are required to avoid
dissatisfaction. These factors describe the job environment/scenario. The hygiene
factors symbolized the physiological needs which the individuals wanted and
expected to be fulfilled. Hygiene factors include:
 Pay - The pay or salary structure should be appropriate and reasonable. It
must be equal and competitive to those in the same industry in the same
domain.
 Company Policies and administrative policies - The company policies
should not be too rigid. They should be fair and clear. It should include flexible
working hours, dress code, breaks, vacation, etc.
 Fringe benefits - The employees should be offered health care plans
(mediclaim), benefits for the family members, employee help programmes, etc.

a. Motivational factors- According to Herzberg, the hygiene factors cannot be regarded as

motivators. The motivational factors yield positive satisfaction. These factors are
inherent to work. These factors motivate the employees for a superior performance.
These factors are called satisfiers. These are factors involved in performing the job.
Employees find these factors intrinsically rewarding. The motivators symbolized the
psychological needs that were perceived as an additional benefit. Motivational factors
include:
 Recognition - The employees should be praised and recognized for their
accomplishments by the managers.
 Sense of achievement - The employees must have a sense of achievement. This
depends on the job. There must be a fruit of some sort in the job.
  Growth and promotional opportunities - There must be growth and
advancement opportunities in an organization to motivate the employees to
perform well.
 Responsibility - The employees must hold themselves responsible for the work.
The managers should give them ownership of the work. They should minimize
control but retain accountability.
 Meaningfulness of the work - The work itself should be meaningful, interesting
and challenging for the employee to perform and to get motivated.

3. Mc cllen Achievement theory

 McClelland's Human Motivation Theory states that every person has one of three
main driving motivators: the needs for achievement, affiliation, or power. These
motivators are not inherent; we develop them through our culture and life experiences.
 Achievers like to solve problems and achieve goals. Those with a strong need for
affiliation don't like to stand out or take risk, and they value relationships above
anything else. Those with a strong power motivator like to control others and be in
charge.
 You can use this information to lead, praise, and motivate your team more effectively,
and to better structure your team's roles.

4. ERG Theory

 Clayton Paul Alderfer is an American psychologist who developed Maslow’s

hierarchy of needs into a theory of his own. Alderfer’s ERG theory suggests that
there are three groups of core needs: existence (E), relatedness (R), and growth (G)
—hence the acronym ERG. These groups align with Maslow’s levels of physiological
needs, social needs, and self-actualization needs, respectively.
 Existence needs concern our basic material requirements for living. These include
what Maslow categorized as physiological needs (such as air, food, water, and shelter)
and safety-related needs (such as health, secure employment, and property).
 Relatedness needs have to do with the importance of maintaining interpersonal
relationships. These needs are based in social interactions with others and align with
Maslow’s levels of love/belonging-related needs (such as friendship, family, and
sexual intimacy) and esteem-related needs (gaining the respect of others).
 Finally, growth needs describe our intrinsic desire for personal development. These
needs align with the other portion of Maslow’s esteem-related needs (self-esteem,
self-confidence, and achievement) and self-actualization needs (such as morality,
creativity, problem-solving, and discovery).

5. Equity theory

Equity theory is a theory of motivation that suggests that employee motivation at work is
driven largely by their sense of fairness. ... If employees perceive that their ratio of inputs
to outcome is not equitable with that of their peers, they may become demotivated and
dissatisfied with their job.
6. Goal setting theory
In 1960’s, Edwin Locke put forward the Goal-setting theory of motivation. This theory states that
goal setting is essentially linked to task performance. It states that specific and challenging goals
along with appropriate feedback contribute to higher and better task performance.

In simple words, goals indicate and give direction to an employee about what needs to be done
and how much efforts are required to be put in.

The important features of goal-setting theory are as follows:

 The willingness to work towards attainment of goal is main source of job motivation.
Clear, particular and difficult goals are greater motivating factors than easy, general and
vague goals.
 Specific and clear goals lead to greater output and better performance. Unambiguous,
measurable and clear goals accompanied by a deadline for completion avoids
misunderstanding.
 Goals should be realistic and challenging. This gives an individual a feeling of pride and
triumph when he attains them, and sets him up for attainment of next goal. The more
challenging the goal, the greater is the reward generally and the more is the passion for
achieving it.
 Better and appropriate feedback of results directs the employee behaviour and
contributes to higher performance than absence of feedback. Feedback is a means of
gaining reputation, making clarifications and regulating goal difficulties. It helps
employees to work with more involvement and leads to greater job satisfaction.
 Employees’ participation in goal is not always desirable.
 Participation of setting goal, however, makes goal more acceptable and leads to more
involvement.

7. Expectancy Balance theory

The expectancy theory was proposed by Victor Vroom of Yale School of Management in 1964.
Vroom stresses and focuses on outcomes, and not on needs unlike Maslow and Herzberg. The
theory states that the intensity of a tendency to perform in a particular manner is dependent on
the intensity of an expectation that the performance will be followed by a definite outcome and
on the appeal of the outcome to the individual.

The Expectancy theory states that employee’s motivation is an outcome of how much an

individual wants a reward (Valence), the assessment that the likelihood that the effort will lead to
expected performance (Expectancy) and the belief that the performance will lead to reward
(Instrumentality).

In short, Valence is the significance associated by an individual about the expected outcome. It is

an expected and not the actual satisfaction that an employee expects to receive after achieving
the goals.

Expectancy is the faith that better efforts will result in better performance. Expectancy is
influenced by factors such as possession of appropriate skills for performing the job, availability
of right resources, availability of crucial information and getting the required support for
completing the job.
Instrumentality is the faith that if you perform well, then a valid outcome will be there.
Instrumentality is affected by factors such as believe in the people who decide who receives
what outcome, the simplicity of the process deciding who gets what outcome, and clarity of
relationship between performance and outcomes. Thus, the expectancy theory concentrates on
the following three relationships:

 Effort-performance relationship: What is the likelihood that the individual’s effort be

recognized in his performance appraisal?
 Performance-reward relationship: It talks about the extent to which the employee
believes that getting a good performance appraisal leads to organizational rewards.
 Rewards-personal goals relationship: It is all about the attractiveness or appeal of the
potential reward to the individual.

Vroom was of view that employees consciously decide whether to perform or not at the job. This
decision solely depended on the employee’s motivation level which in turn depends on three
factors of expectancy, valence and instrumentality.

8. Agency Thoery

Agency Theory explains how to best organize relationships in which one party determines
the work while another party does the work. Agency theory assumes both the principal
and the agent are motivated by self-interest. ... This assumption of self-interest dooms
agency theory to inevitable inherent conflicts.