Subsistence theory of wages

From Free net encyclopedia

In economics, the subsistence theory of wages stated that real wages in the long run will tend to the value needed to keep the workers' population constant.

This followed from Malthus' demographic theory, according to which the growth rate of population was – mainly for cultural reasons – an increasing function of wages, reaching a zero for a unique positive value of the real wages rate, called the subsistence wage. Assuming the demand for labour to be a given monotonically decreasing function of the real wages rate, the theory then predicted that, in the long-run equilibrium of the system, labour supply (i.e. population) will be equated to the numbers demanded at the subsistence wage. The justification for this was that when wages are higher, the supply of labour will increase relative to demand, creating an excess supply and thus depressing market real wages; while when wages are lower, labour supply will fall, increasing market real wages. This would create a dynamic convergence towards a subsistence-wage equilibrium with constant population.

As David Ricardo first noticed, this prediction would not come true as long as new investment or some other factor caused the demand for labour to increase at least as fast as population: in that case the equality between labour demanded and supplied could in fact be kept with real wages higher than the subsistence level, and hence an increasing population. In most of his analysis, however, Ricardo kept Malthus' theory as a simplifying assumption.

In modern times, the predictions of Malthus' Iron law of wages have been falsified not only by continuing economic growth – along the lines already known to Ricardo – but also by the demographic transition whereby in richer societies demographic growth becomes a falling function of real incomes and wages, upturning Malthus' demographic theory.