Mr. Tenney teaches economics at Northern Nevada Community College in Elko, Nevada.
“The produce of labour constitutes the natural recompence or wages of labour.” These words were penned by the great Adam Smith more than two centuries ago; yet his message is very clear, and it remains relevant today: The wage rate is determined by the productivity of labor. Adam Smith also appropriately observed that wages depend on the voluntary agreements made between the worker and the employer: “What are the common wages of labour, depends every where upon the contract usually made between those two parties, whose interests are by no means the same. The workmen desire to get as much, the masters to give as little as possible.”
Beyond this point however, some of the classical economists, including Adam Smith, had an incomplete understanding of the concept of value as it is understood today. According to the accepted theory of their day, which is at least partially accepted by many people today as well, the value of any product is determined by the wages of the labor which produced it. Perhaps related to their belief in this “labor theory of value,” or perhaps out of genuine sympathy for the plight of the working man, they felt that employees had great disadvantages relative to their employers.
Adam Smith taught that because employers were fewer in number, they were able to combine forces against the workers and force the workers into compliance with their terms. In his view then, employers would be able to create a monopoly of demand for labor, which would allow employers to restrict their demand for labor and lower the wage rate to a level consistently lower than the marginal revenue realized by the firm through the productive efforts of the employees.
Another economist from the classical period, Jean-Baptiste Say, wrote of the “urgency” of the workers’ needs relative to those of the employers. According to Say:
The wages of the labourer are a matter of adjustment and compact between the conflicting interests of master and workman; the latter endeavoring to get as much, the former to give as little, as he possibly can; but, in a contest of this kind, there is on the side of the master an advantage over and above what is given him by the nature of his occupation. The master and the workman are no doubt equally necessary to each other; for one gains nothing but with the other’s assistance; the wants of the master are, how ever, of the two, less urgent and less immediate.
Taking from the sentiments of great thinkers such as Smith and Say, others called for the organization of workers into unions with the purpose of raising wage rates. The socialist thinker Karl Marx went still another direction with the labor theory of value, and wrote about the outright “exploitation” of the workers by capitalists.
But what of this so-called “disadvantage” on the part of labor? Is it really possible for an employer to monopolize the demand for labor, and thereby consistently push the wage rate below the productivity of that labor? Careful thinking about the nature of labor markets in the real world reveals the truth of the matter. Employers do not enjoy any general advantage over workers, and it is impossible for employers to join together to create a “monopoly of demand” for labor services. It is impossible to have a monopoly over the demand for labor because man’s desires to have services performed are dynamic—not limited in the manner that the supply of goods and services are. There is always work that can be done in society, and no one firm or one industry can possibly be the sole demander of labor services.
In the later part of the nineteenth century, the Austrian economist Carl Menger discovered the error of the labor theory of value, and replaced it with a subjective-value approach. In addition to Menger, others have articulated the subjective-value theory, and meaningfully built upon it. Under this approach, the value of a product is determined subjectively by the prospective consumer as he weighs the benefit from consuming a unit of the good against the cost sacrificed in order to obtain the product.
This value is often referred to as the marginal utility of the good, and is specific to the individual perceptions of the market participant. Thus inputs into the production process, such as materials and labor, are valued at the amount necessary to attract these productive factors away from their alternative uses. Logically then, wage rates as well as the price of other inputs are determined subjectively, based on the final value attached to the final product by the consumer. This is quite different, and in fact the opposite, from the prior thinking which held that the value of the final product was obtained from the value of the inputs into the productive process.
Perhaps the most thorough expositions of the subjective-value approach to the concept of valuation were provided by Ludwig von Mises. Concerning the possibility of a monopoly of demand for labor, he denies that any such situation can persist in any meaningful way in an unhampered market economy. In the real world, labor is not homogeneous. The demand for labor services is a demand by business firms for a specific type of labor that is suitable to render specific services. In order to obtain these specific services, the entrepreneur must offer these workers incentives sufficient to entice them to withdraw their efforts from other endeavors which the worker might choose to engage in. These inducements are offers of higher pay, and can be made by higher wage levels, greater employee benefits, or a combination of both.
Labor’s “Inability to Wait”
Professor Mises has further pointed out that the “inability to wait” or “urgency” argument, that was a major focus of the classical economists, is not valid. The “inability-to-wait” argument assumes that the difference between the wage set by the marginal productivity of the worker and the imagined lower rate set by the so-called monopoly power of the employer is pocketed as additional profit by the entrepreneur. In the Mises view, an employer attempting to act as a monopolist in his hiring practices would have to have an effective monopoly in the selling of his product, the purchasing of other productive inputs, and all other aspects of his business. Because productive inputs, and labor in particular, are limited, and can and will be used in alternative uses by competitors and non-competitors alike, it is impossible for the entrepreneur to act as a monopolist to persistently depress the wage below the rate conditioned by the marginal productivity of the laborer.
The businessman can succeed in lowering workers’ pay only by restricting his demand for labor, which will have the effect of reducing the quantity of labor hired and used. Other employers, and would-be employers, seeing these bargain rates for labor, will want to take advantage of the opportunity of the lower labor prices, increase their demand for labor, and push the wage back up to the level prescribed by the marginal productivity of the labor.
It must be conceded that in a world where such competitive restrictions as occupational licensing and business permits dominate the industry, these measures will tend to restrict the competitive bidding for certain types of labor. Although these anti-competitive measures are not in accordance with an efficiently operating economy, and the elimination of such measures in an economy should be encouraged, it is naive to believe that such measures will be successful in preventing potential demanders of labor from bidding up wage rates in order to remain competitive.
There are many margins on which a firm can effectively compete when it comes to satisfying the desires of consumers. A higher wage rate (or equivalent employee benefits of one kind or another) paid to workers might be the very edge that a firm needs in order to compete successfully in the market for its products.
The very notion that workers compete with their employers in a meaningful way in setting wage rates is somewhat misleading from the start. An employer’s primary competition in the hiring and use of productive inputs, including labor, is from other entrepreneurs who use, or can use, the same inputs in other productive processes. It is not necessary for two firms to be in the business of producing the same product, or even in related industries, in order to vie for available labor services. The non-specific nature of labor services assures that those services will be desired by any number of firms. Professor Paul Heyne has pointed out: “Workers compete against workers, corporate employers against corporate employers. And this is the competition that affects wage rates. Workers cannot successfully insist on the wage they think they deserve if other workers are willing to supply very similar services at lower wage rates.”
Thus we see that the competition that employers have from other employers of all kinds assures that any bargain-priced labor will be competed for by the employers bidding up the wage rate to the value of the output of that labor.
In summary, the demand for labor services is treated by business firms in the same manner as the demand for other inputs to the productive process. Because the efforts of workers can be put to use in a variety of ways by a variety of firms that may or may not be competing directly in the product markets, the price that firms will be required to pay for these services will tend toward the value of the workers’ output as perceived by the end users of the products that they produce.
There is no lack of demand for labor by employers acting either on their own or in tacit combinations as monopolists, because there are no limits to the number of productive labors that are required to be performed in society. 
- Adam Smith, The Wealth of Nations (Chicago: The University of Chicago Press, 1976), p. 72.
- lbid., p. 74.
- Jean-Baptiste Say, A Treatise on Political Economy, First American Ed. (Philadelphia: Claxton, Ramsen, and Haffelfinger, 1821; repr., New York: Augustus M. Kelley Publishers, 1971), p. 338.
- Eugen von Bohm-Bawerk, Value and Price (Spring Mills, Pa.: Libertarian Press), pp. 28-29.
- Paul Heyne, The Economic Way of Thinking (New York, Macmillan Publishing Company, 1991), p. 307.