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(Course Hero, 2017)
Course Hero. "The Wealth of Nations Study Guide." September 28, 2017. Accessed October 23, 2018. https://www.coursehero.com/lit/The-Wealth-of-Nations/.
Course Hero, "The Wealth of Nations Study Guide," September 28, 2017, accessed October 23, 2018, https://www.coursehero.com/lit/The-Wealth-of-Nations/.
Building on the three-part model developed in Chapter 6, Smith offers an analysis of wages, the first and most basic component of commodity prices. He observes that wages are usually set by employers, who almost always have more bargaining power than their employees and naturally prefer to pay the lowest possible wage. Still, he points out, there is "a certain rate below which it seems impossible to reduce ... the ordinary wages even of the lowest species of labor." This rate, called a subsistence wage in modern terminology, is the amount that allows workers to supply themselves and their families with the bare essentials of life.
Smith then considers the factors that lead employers to pay their workers more than subsistence wages, given their superior bargaining position. Wages rise, he asserts, when a country is experiencing a period of economic growth, and employers must "bid against one another" for workers. Conversely, when a country is experiencing economic decline, wages decline. Thus, for Smith, it is the direction of economic progress that matters, not the country's overall wealth. Hence, wages are higher in the American colonies, which are poorer than Great Britain but are growing faster economically.
Finally, Smith takes up a question whose answer, to him, seems obvious: Are high wages good for the country in general? Since most people of working age are wage laborers, he observes, high wages increase the standard of living for most of the population. Beyond this, however, Smith attributes several other positive effects to high wages. They encourage people to marry and have children, he says, thus adding to the labor pool in future generations. This, in turn, creates a kind of positive feedback loop (although Smith never uses this term)—the bigger the labor pool, the more complete the division of labor can be, leading to improved manufacturing technologies and cheaper, more plentiful goods. When goods are cheap, the same amount of money translates to greater purchasing power, in effect raising wages even further. Thus, Smith concludes, higher wages benefit not only the laborers, but society at large.
Although Smith laid the groundwork for the modern economic treatment of wages, his thoughts here are far from the last word on the subject. The view established by Smith is called the subsistence theory of wages, since he asserts wages will always drift down toward the minimum necessary to support life. The legally mandated minimum wage is a late-19th-century invention, and thus receives no consideration from Smith. Only a shortage of labor, Smith argues, can give employers a motive for offering more than this minimum. This, in turn, explains his interest in the direction of an economy's progress—a rapidly growing economy has an almost continual labor shortage, as new capital is generated faster than people can be hired to put it to use. Similarly, a period of economic contraction is one in which capital, not labor, is in short supply. When a country's economy stagnates (or, to use Smith's phrase, "neither [goes] backwards nor forwards"), capital and labor will generally exist in equilibrium.
Various modern theories have arisen to challenge the subsistence model. One notable example is the marginal productivity theory of wages, developed in the late 19th century by a group of Anglo-American economists. Much like the Austrian school's theory of marginal utility (see Insight to Book 1, Chapter 4), the theory of marginal productivity emphasizes what happens when small, additional amounts of labor are hired or fired. Simply put, the marginalist view holds that an employer will only purchase additional units of labor if they are expected to be profitable, whether or not the resultant wage is a living wage. This theory has the benefit of accounting for some of the phenomena noted by Smith, but it is not fully incorporated into his theory—for example, the low wages given to those who do professionally what richer people do recreationally, such as gardening or fishing. Another modern wage theory that forms an interesting counterpoint to Smith is the bargain theory, which describes wages as the result of a complex set of negotiations between employer and employee. Smith touches on the importance of negotiations only incidentally in his book, when he observes that employers are legally free to combine against their employees, but not vice versa. To "combine" was to form a union or cartel—in this case, to collude against employees by setting a maximum wage. In Smith's time, workers were legally forbidden from "combining" to enforce a minimum wage, but employers could combine freely to do the opposite.