Iron law of wages has its roots in the work of classical economists, although the term was first used by German political economist FERDINAND LASSALLE (1825-1864). It postulates that wages will always revert to subsistence levels.
A rise in wages triggers an increase in the population, prompting a fall in wages back to subsistence levels. Also known as the subsistence theory of wages, this principle has no current relevance.
Also see: equilibrium theory
F J G Lassalle, Open Letter to the National Labor Association of Germany (Berlin, 1863)
According to Alexander Gray, Ferdinand Lassalle “gets the credit of having invented” the phrase the “iron law of wages”, as Lassalle wrote about “das eiserne und grausame Gesetz” (the iron and cruel law).
According to Lassalle, wages cannot fall below subsistence wage level because without subsistence, laborers will be unable to work. However, competition among laborers for employment will drive wages down to this minimal level. This follows from Malthus’ demographic theory, according to which population rises when wages are above the “subsistence wage” and falls when wages are below subsistence. Assuming the demand for labor to be a given monotonically decreasing function of the real wage rate, the theory then predicted that, in the long-run equilibrium of the system, labor supply (i.e. population) will rise or fall to the number of workers needed 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, in accordance with supply and demand theory.
As English political economist David Ricardo noticed, this prediction would not come true as long as new investment, technology, or some other factor causes the demand for labor to increase faster than population: in that case, both real wages and population would increase over time. The demographic transition (a transition from high birth and death rates to low birth and death rates as a country industrializes) changed this dynamic in most of the developed world, leading to wages much higher than the subsistence wage. Even in countries which still have rapidly expanding populations, the need for skilled labor in certain occupations causes some wages to rise much faster than in others.
To answer the question of why wages might fall towards a subsistence level, Ricardo put forth the law of rent. Ricardo and Malthus debated this concept in a lengthy personal correspondence.
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. According to Terry Peach, economists interpreting Ricardo as having a more flexible view of wages include Haney (1924), J. R. Hicks (1973), Frank Knight (1935), Ramsay (1836), George Stigler (1952), and Paul Samuelson (1979). She sees Ricardo, for example, as being closer to the more flexible views of population characteristic of economists prior to Malthus. The theorist Henry George noticed that Ricardo’s Law of Rent did not imply that a reduction of wages to subsistence is an immutable fact, but that it instead points the way towards reforms that could greatly increase real wages, such as a land value tax. 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 the natural wage 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…
Ricardo also claimed that the natural wage was not necessarily what was needed to physically sustain the laborer, but could be much higher depending on the “habits and customs” of a nation:
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.[excessive quote]
Socialist critics of Lassalle 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 criticized Lassalle for misunderstanding David Ricardo. Marx also noted that the foundation of what he called “modern political economy” needs, for the theory of value, only for wages to be a given magnitude. He did so in praising the Physiocrats.