Iron law of wages

The Subsistence Theory of Wages, also known as the Iron Law of Wages, is an alleged law of economics that asserts that real wages always tend, in the long run, toward the minimum wage necessary to sustain the life of the worker. The theory was first named by Ferdinand Lassalle in the mid-nineteenth century, although the idea might be said to have been formulated by Thomas Malthus.

According to Lassalle, wages cannot fall below subsistence level because without subsistence, laborers will be unable to work. However, competition among laborers for employment will drive wages down to this minimal level, since there is always someone who is willing to work for just enough food to keep him alive. The unlimited supply of workers follows from Malthus's demographic theory, according to which populations always expand until limited by war, disease, or famine. Applying the Mathusian Principle to the labour supply, unless workers are paid at a rate low enough to insure the starvation of those who are too old, infirm, or unfit for labour, the number of workers will increase until the starvation level is reached. The rate of pay that will keep young, healthy workers from starvation is called the "subsistence wage". Assuming the demand for labor 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, labor 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 labor will increase relative to demand, creating an excess supply and thus depressing market real wages; when wages are lower, labor supply will fall, increasing market real wages. This would create a dynamic convergence towards a subsistence-wage equilibrium with constant population.

Ricardo observed that in the England of his day, workers were in fact paid something above a subsistance wage. He attributed that fact English labour being supported, in part, by the labour of subsistance workers overseas, especially in Ireland. He also observed that, while the Iron Law always held in the long term, in the short term is was possible for new investment to increase at a greater rate than the population, and so create a demand for labour at a higher rate than the subsistance wage. In most of his analysis, however, Ricardo kept Malthus' theory as a simplifying assumption.

Lassalle

According to Alexander Gray, Ferdinand Lassalle "gets the credit of having invented" the phrase the "Iron Law of Wages". Lassalle actually wrote about "das eherne und grausame Gesez" (the brazen and cruel Law), which Gray notes refers to another metal.

Ricardo

The content of the iron law of wages has been attributed to economists writing earlier than Lassalle. For example, Antonella Stirati notes that Joseph Schumpeter claimed that Anne-Robert-Jacques Turgot first formulated the concept. Some (e.g., John Kenneth Galbraith) attribute the idea to David Ricardo, who supposedly justified it on the basis of Malthus's theory of population.

Antonella Stirati disputes these attributions to Classical economists other than Malthus. She sees Ricardo, for example, as being closer to the more flexible views of population characteristic of economists prior to Malthus. Ricardo drew a distinction between a natural price and a market price. For Ricardo, the natural price of labor was the cost of maintaining the laborer. However, Ricardo believed that the market price of labor or the actual wages paid could exceed subsistence level indefinitely due to countervailing economic tendencies:

"Notwithstanding the tendency of wages to conform to their natural rate, their market rate may, in an improving society, for an indefinite period, be constantly above it; for no sooner may the impulse, which an increased capital gives to a new demand for labor, be obeyed, than another increase of capital may produce the same effect; and thus, if the increase of capital be gradual and constant, the demand for labor may give a continued stimulus to an increase of people..."

Furthermore, not only did Ricardo believe that the market price of labor could long exceed the subsistence or natural wage, he also claimed that the natural wage was not what was needed to physically sustain the laborer, but depended on "habits and customs":

"It is not to be understood that the natural price of labor, estimated even in food and necessaries, is absolutely fixed and constant. It varies at different times in the same country, and very materially differs in different countries. It essentially depends on the habits and customs of the people. An English laborer would consider his wages under their natural rate, and too scanty to support a family, if they enabled him to purchase no other food than potatoes, and to live in no better habitation than a mud cabin; yet these moderate demands of nature are often deemed sufficient in countries where 'man's life is cheap', and his wants easily satisfied. Many of the conveniences now enjoyed in an English cottage, would have been thought luxuries in an earlier period of our history."

Criticism of the Iron Law of Wages

Mainstream criticism

In modern times, the predictions of Lassalles' subsistence theory of wages have been discredited 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. Thus, mainstream economics rejects the subsistence theory of wages.

Socialist criticism

Socialist critics of Lasalle and of the alleged Iron Law of Wages, such as Karl Marx, argued that although there was a tendency for wages to fall to subsistence levels, there were also tendencies which worked in opposing directions. Marx criticized the Malthusian basis for the Iron Law of Wages. According to Malthus, humanity is largely destined to live in poverty because an increase in productive capacity results in an increase in population. Marx also criticized Lasalle for misunderstanding David Ricardo.

Austrian criticism

Ludwig von Mises argues that if one adopts this reasoning in order to demonstrate that in the long run no rise in the average wage rate above the minimum is possible, one must also imply that no fall in the average rate can occur.