Why Wages Rise: 3. Dividing The Pie

Dr. Harper is a member of the staff of the Foundation ]or Economic Education.

Real wages in the United States are about five times as high as they were a century ago. The first in this series of articles showed that this rise apparently is not, as commonly believed, due to the growth of labor unions.

The second article in the series showed the close parallel between changes in incomes and productivity. Higher wages come from increased output per hour of work. This is not a new or profound discovery. For how could consumption be greater than production?

Wages, however, are not the only part of the economic pie. Why, then, couldn’t wages be raised by giving the employee a larger share? That is the question to be dealt with in this article.

For purposes of this discussion, the pie of personal incomes may be thought of as divided into two parts. One is the pay for work done currently and the other is pay for the use of savings—income from work done in the past and not used for consumption at that time.

Pay for work done currently includes wages and salaries, or the equivalent in some other form of economic reward. On the other hand, income from the use of savings includes interest on money loaned, dividends on shares of ownership, rent on real estate, and the like.

A person who has never saved a cent and who owns no tools of his own may be getting all his income from work done currently, using tools that have been provided by the savings of others. Another person—perhaps an aged person—may be idle so far as current economic effort is concerned, getting all his income as pay for the use of his past savings. More commonly, a person receives part of his income from each of these sources, getting some from current effort and some from savings.

Some persons work for themselves, using in full or in part tools provided from their own savings. And some persons work for others.

There are all sorts of combinations of income from these two sources. But in some form or degree, essentially everyone in the United States has savings or property and is therefore a capitalist. Most persons also have some income from work done currently.

Present Divisions of the Pie

Information about the present division of the economic pie can be found in figures supplied by the Department of Commerce.*

The average personal income in the United States was about $4,600 in 1955. Of this amount, something like 85 per cent, or $3,910, appears to have been pay for work done currently. The remaining 15 per cent, or about $690, was pay to savers who were providing the tools of production in one form or another.

Were the entire pie to go to wage earners and others as pay for current work—as advocated by Karl Marx, to be explained shortly u wages could go up from 85 to 100, or about one-sixth. And even this much rise could occur only if there were no reduction in the size of the total pie—that is, in total production.

But let’s assume that no decline were to occur in total production. How important, then, would be the rise in wages compared with the rise caused by increased productivity which was discussed in the two previous articles? Since 1917, wage rates have risen with increased productivity at about 2.5 per cent a year. Thus in six years’ time this rise in wages would equal the 15 per cent increase possible from getting all the remainder of the pie. Or to put it another way, productivity increases during the past working generation have raised wages perhaps six times as much as could possibly come from diverting to wages every cent of current returns for savings.

Wages can, furthermore, continue to rise indefinitely so long as productivity continues to increase. But a gain in wages from a larger share of the pie is a gain which can be repeated only once. Any increase from that source can go only from the 85 to 100 per cent, and no further. A dead end to improvement is then reached, because a pie of more than 100 per cent is not possible.

Adverse Effects on Savings

Capital created from savings makes possible a large part of our production. It apparently raises the average income in the United States to a level of $4,600 instead of perhaps $200 to $250—as it would be if there were essentially no tools. This teamwork between those who save and those who use the tools is the reason for our high and rising wage rates. Without a continuous and increasing supply of tools, the gear wheels of economic progress would be slowed or even stopped.

Without a return for savings, where would future tools come from to enhance the fruits of current effort? Who would then be willing to save and invest in tools, if obliged to take all the risk without any prospect of return? Few persons would save till tomorrow what they could consume today, unless they were rewarded for doing so.

During the last quarter century inroads have been made into the reward for savings, with serious consequences. The rate at which personal savings are being invested in productive tools, as compared with earlier decades, has declined. Among what we call “savings” are government bonds, which in reality are investments in a deficit of the government—not a productive tool any more than would be your tax receipt. And some of what is called “savings” has been forced upon individuals, in a sense, as a direct or indirect consequence of present tax policies.

Over the last quarter century the costs of government have nearly trebled in proportion to personal incomes, going up from 12 to 34 per cent. It is impossible, of course, to know for certain how heavily this has been a burden on pay for savings as compared to pay for current work. But there have been large increases in the graduated taxes on both individual incomes and corporate incomes—the “double tax”—and the government has held down interest rates in order to help the sale of its (deficit) bonds. This has unquestionably reduced the share of the pie going as pay for real savings.

History of an Idea

An increased share of the pie going to wages, at the expense of the share for savings, is not just an accident. It is the wayward son of a notorious ideological ancestor. Its pedigree needs critical study by those of us who have faith in a system of personal responsibility and freedom of opportunity in economic affairs. Plausible on the surface, this idea has seduced many who today denounce it by name but embrace its substance.

During most of his ten million or more years of history, man has presumably been his own employer, producing most of his own food, raiment, and shelter—though, of course, we do not know the unknown. But if it is true that in most instances he worked for himself, or perhaps joined other huntsmen and producers in informal cooperation, such a type of livelihood would hardly have permitted him to embrace the notion that one’s welfare can be ira-proved by claiming a larger share of his own pie. No sane person is going to demand more wage from himself for his muscular work, at the expense of his management self or his tool-owning self.

Somewhere along man’s historic trail some men began to enslave others to work for them. Slaves doubtless wanted a larger share of what was produced, but there wasn’t much they could do about it because the master held full ownership of the slave. And anyhow, in those early slave-holding days each person was able to produce little more than enough to keep himself from starving, and so a master couldn’t take much of what a slave produced or he would have a slave no more.

In more recent times the voluntary employer-employee arrangement among free men has largely displaced slavery throughout the world. Some work for others at a wage. They may want to do so as a way of gaining the use of tools with which to work, or because for some other reason the wage offered is more enticing than the rewards in prospect while working for themselves.

By this arrangement, persons sell in the market what they have jointly produced. And when this is done, the problem of dividing the pie arises in a new form. Instead of a slave who can do nothing about it except bemoan his plight as he wearily hoes his row, the employee can—if he so desires—go elsewhere to seek an easier livelihood or higher pay.

Labor and Surplus Value Theories

From this new economic climate there arose, in the course of time, the labor theory of value which has become highly appealing to some among the employee class. It is often used in one way or another in bargaining for wages, which are now a form of price and therefore the object of higgling and haggling in the market, as is the price of wheat or potatoes.

On its surface the labor theory of value seems plausible enough. Suppose you are a self-employed person and consume what you produce. If you have to work twice as long to produce one thing you want as to produce another, it would seem that you must prize the former twice as much as the latter. If this were not so, wouldn’t you have produced something else instead? Something requiring three times the labor must be prized three times as much, etc. In like manner, the labor theory of value assumes that labor is the essential ingredient by which to measure all value.

The labor theory of value had just nicely gained some respectable acceptance among economists of that early day when along came a man—Karl Marx—with a cause which fitted this theory tragically well. Others before Marx had, of course, held essentially the same views about value. But Marx set in motion forces which have brought the world to the brink of disaster in economic, social, and political affairs.

Having accepted the labor theory of value from the classical economists, Marx a century ago attempted to explain how profit to private owners worms its wily way into exchange by way of the capitalist system. All return on capital, according to Marx, comes out of the value that labor has created and is just another form of theft that capitalism has tried to make respectable. This concept of profits is a logical descendant of the labor theory of value.

Marx viewed a return on capital in the same manner as a doctor views a parasite feasting on his patient. For if all value comes from labor and is in proportion thereto, any share of the pie going to anyone other than the laborer, in proportion to his labor, must be the result of a parasitical attachment by capitalists.

The devilment in the capitalist setup, according to Marx, is made possible by the private ownership of the land, materials, and tools with which labor does its work. The capitalist owner who holds title to these material means of production can, in this way, claim ownership of the product. He can then withhold any part of it he wishes from the laborer—the one who Marx claimed was the rightful owner of all of it because he is the one who created all its value in the first place.

So pay for the use of capital is like loot from theft, as Marx saw it. He said that the absolute amount of profit is equal to the absolute amount of surplus value. Persons who hold these Marxian beliefs charge that the laboring man is “exploited” by the capitalist owner; that he is a “wage-slave” of the capitalist.

The term surplus value was defined by Marx, then, as the part of production which, under private ownership, is confiscated by the capitalist from its rightful owner, the laborer. That is the part which all Marxians believe can and should be reclaimed by labor. The amount of surplus value, by this concept, measures the amount that wages could rise aside from any increase in hourly output. Were labor to regain this lost part of the economic pie, it would simply mean taking it back from the capitalist thief.

Some ten million years ago man’s tools probably were simple ones, like a stone fastened to the end of a stick. We may assume incomes then were essentially all reward for current work, rather than being a reward for savings from past effort stored in the form of tools to aid in production. The labor theory of value may seem to have applied fairly well then because essentially all production was the result of direct and current labor. True or false, the surplus value theory could hardly have been of concern then, and putting it into practice could have done little damage to their meager living.

But today, being as dependent as we are on tools, the surplus value theory is a sort of economic bomb which, if infused into action, could do unbelievable damage. Were the “justice” of that theory to be put into practice, we would probably be writing articles about why wages fall rather than why wages rise.

The problem of dividing the pie should be left to the free market of individual choices among employees and employers; consumers and producers; investors and borrowers; traders of all sorts, everywhere in exchange. If left to these free individuals, rather than to become the handles of power in politics or among organizations representing any of these special interests, the decisions will be in the best interests of all.

Wherever the pie is divided by the free market, one thing seems sure: Marx’ surplus value theory will be vetoed. For persons will continue, as they have over the past few centuries in our relatively free United States, to recognize a bargain when they see one. That bargain is tools. Of our total output, perhaps as much as 95 per cent is because of the use of tools. And this is at a cost of only about 15 per cent of total output, as pay to those who have saved to create these tools. That, and not Marx’ concept, is the miracle that creates a surplus of value.

In the next article I propose to show how it has been possible for savings to increase production as much as they have.

Foot Notes

* Survey of Current Business, National Income Number, July 1955, and corresponding issues in earlier years. United States Department of Commerce.

Read the next part of this series here