The traditional theory of wages has its roots in 19th-century economic thought and has been attributed to English economist David Ricardo and German socialist Ferdinand Lasalle. The theory, known as the Iron Law of Wages, asserts that in the long run, wages tend toward the minimum level necessary for the worker to live. This occurs because of competition among workers for jobs. Under this theory, wages cannot fall below a subsistence level because workers would not be able to live.
The Iron Law of Wages has its roots in the work of 18th-century English philosopher and economist Thomas Robert Malthus, who wrote that higher wages trigger increases in the population. This means a greater supply of workers, which exerts downward pressure on wage levels. Karl Marx, co-author of "The Communist Manifesto" and other influential socialist works, was a critic of the traditional theory of wages, especially its Malthusian roots. Marx held that workers were destined to live in poverty not because of wages, but because increase in capitalist production capacity triggers population increases.
Gregory Mankiw, a Harvard economist, former White House adviser and author of "Principles of Economics," writes that most economic analyses of wages assume that wage levels reflect an equilibrium between the supply of workers and the demand for labor. However, he points out instances in which wages are set above this equilibrium. Minimum wage laws, for example, pay some workers more than they might receive in an unregulated labor market. In addition, companies in which workers have union representation pay their workers at higher levels than they would pay if the union was not present.
An alternative to the Iron Law of Wages is the efficiency wage theory. This holds that many companies pay wages above the subsistence level because it is profitable to do so in the long run. According to this perspective, paying higher wages makes workers more productive, reduces turnover and attracts workers of higher quality.