Month: November 2020

Wage differentials have a great economic and social significance, for they are directly related to the allocation of the economic resources of a country, including manpower, growth of the national income, and the pace of economic development.

Social welfare activity depends, in a large measure, on such wage differentials as will:

(a) Cause labour to be allocated among different occupations, industries and geographical areas in the economy in such a manner as to maximise the national product;

(b) Enable full employment of the resources of the economy to be attained; and

(c) Facilitate the most desirable rate of economic progress.

Wage differentials reflect difference in the physical and mental abilities of workers, differences in productivity, in the efficiency of management and in consumer preferences, and act as signposts for labour mobility. By providing an important incentive for labour mobility, they bring about a re­allocation of the labour force under changing circumstances.

Under competitive conditions, wages are determined by conditions of demand (which reflect the productivity of workers) and conditions of supply (which reflect the attractiveness of jobs). The level of wages would depend upon the relative scarcity of supply in relation to demand. Scarcity differentials (which may be due to specific skills and mental abilities) produce wage differentials; and as long as the former as inevitable, the latter, too, would be so.

In other words, wage differentials reflect the different degrees of scarcity of the different categories of labour; and since different categories cannot be reduced to the same degree of scarcity in the market, wage differentials are inevitable.

Wage differentials arise because of the following factors:

(a) Differences in the efficiency of the labour, which may be due to inborn quality, education, and conditions under which work may be done.

(b) The existence of non-competing groups due to difficulties in the way of the mobility of labour from low paid to high paid employments.

(c) Differences in the agreeableness or social esteem of employment.

(d) Differences in the nature of employment and occupations.

The nature and the extent of wage differentials are conditioned by a set of factors such as the conditions prevailing in the market, the extent of unionisation and the relative bargaining power of the employers and workers, the rate of growth in productivity, the extent of authoritarian regulations and the centralisation of decision-making, customs and traditions, the general economic, industrial and social conditions in a country, and a host of other subjective and objective factors operating at various levels.

The prevailing rates of wages, the capacity of an industry to pay, the needs of an industry in a developing economy, and the requirements of social justice also directly or indirectly affect wage differentials.

Compensation plan for salespeople consist of a straight salary plan, a straight commission plan or a combination of salary and commission plan.

1. Straight Salary Plan: It provides stable income and provides freedom from financial uncertainties. But there is no additional incentive for good performance. Example, Straight salary plan can be used in jobs where non-selling activities are more in the total times spent by the salesperson like sales and service engineers. Also, in the case of salespersons, who do more of sales promotion activities in the field.
2. Straight Commission Plan: Here, payment is made as per sales productivity. The person receives no compensation if sales are not made. A high performing salesperson can earn very high commission based on business generated. Example: Selling insurance and financial products.

The disadvantages of the system are:

1. The person may be careless in sending reports on market situation, competition and performance of products.
2. The person may consider individual accounts as private property.
3. May shade prices to make sales.
4. Use high pressure tactics to sell.
5. May push easy-to-sell products.
6. May not focus on new products or difficult to sell products.
7. Salary plus Commission Plan: The plan provides security of stable income and additional income through commission for achieving sales targets. The plan is very useful for maintaining the morale of sales people. Therefore salary plus commission plan is being increasingly used by most of the companies in our country.

Sales Incentives:

The objectives of sales incentive are:

1. Motivation of salesperson to achieve sales targets.
2. Increase selling effort (meeting more number of prospects/customer/extended working hours, selling full range of products, conducting sales campaigns etc.).
3. Increase in sales, market share and profits.

Types of Sales Incentives:

1. Financial incentive: The salesperson is eligible for cash incentive for achievement of sales target/exceeding the sales target. The sales target may be for a quarter or for the whole year.
2. Non-financial incentives: While financial reward is a powerful motivation, money is not the sole motivator. Therefore, companies have come out with non-financial incentive such as recognition of outstanding performance, annual conferences in hill stations/foreign countries, membership in Achievers’ Club, members of the task force, personal letters of commendations, etc. to motivate sales people.
3. Combination of financial and non-financial incentives: Many companies dealing with pharma products, consumer goods and durables are increasingly using a combination of financial and non-financial incentive system to motivate sales people and achieve increase in sales, market share and profits.

Marginal productivity theory of wages is an important theory of wages. This theory was first of all propounded by Thunnen. Later on, economists like Wicksteed, Walras, J.B Clark etc. modified the theory. The marginal productivity theory states that labour is paid according to his contribution in production. A producer hires the services of labour because he possesses the ability to contribute in production. If worker contributes more to production he is paid more wages and if he contributes less, w ages also will be low.

“Marginal productivity of labour refers to change in total revenue by putting one more labourer, keeping all the other factors constant.” Dooley “As a result of competition between employees for labour and between workers for employment, a wage-rate is determined that is equal to the marginal productivity of the labour-force, the employers as a whole are willing to employ.” Prof. S.E. Thomas “The marginal productivity theory contends that in equilibrium each labourer will be rewarded in accordance with its marginal productivity”.

Assumptions:

The marginal productivity theory of wages is based on certain assumptions as stated below:

1. All labourers are equally efficient.
2. Constant technology
3. Perfect competition prevails both in factor and product markets.
4. There is full employment in the economy.
5. Law of diminishing marginal returns apply on the marginal productivity of labour.
6. Labour is perfectly mobile.

Explanation of the Theory:

Under the conditions of perfect competition, wages are determined by the value of marginal product of labour. Marginal product of labour in any industry refers to the amount by which output increases when one more labour is employed. Value of marginal product of labour is the price which the marginal product can fetch in the market. Under the conditions of perfect competition, an employer will go on employing more labourers but, due to the operation of the law of diminishing returns, the marginal product of labour will diminish until a point comes when the value of the increase in the product will be equal to the wages paid to that labourer.

Why Marginal Productivity Theory is Most Satisfactory:

Here we may compare the Marginal Productivity Theory with the earlier classical theories. The Marginal Productivity theory is an improvement over the earlier theories in the following ways:

(i) This theory is not as rigid as the subsistence level theory and other classical theories.

(ii) It takes into consideration the demand for labour by the employers and the supply of labour, although in an indirect form.

(iii) It shows why there are differences in wage rate. Wages according to this theory vary because of marginal productivity differences of different workers.

(iv) It gives importance to the productivity of labour.

Criticism:

The marginal productivity theory of wages also suffers from certain defects as:

1. Unrealistic Assumptions:

The foremost defect of the theory is that it is based on unrealistic assumptions like perfect competition, homogeneous character of labour etc. All these assumptions do not prevail in the real world.

2. Incomplete:

Again, this theory fails to take into account that labour is also a function of wages. Less productivity may be the effect of low wages which adversely affects the efficiency of labour and in turn reduces the labour productivity. Thus, the theory is incomplete in all respects.

3. Static Theory:

Lord J.M Keynes criticized the theory as it is based on static conditions. It is only true when there occurs no changes in the economy. But in real practice it cannot be so. Change is the law of nature, though it may come gradually.

4. One Sided:

The marginal productivity theory is one sided. It takes into consideration only the demand side and ignores the supply side.

5. Fails to determine Wages:

This theory only guides the employer to employ workers up to the level where their marginal productivity equals price. But, it does not tell how the wages are determined.

6. Long Period:

The theory concerns itself with the long run. It explains that wages will be equal to MRP and ARP in the long run but, the long run like tomorrow never comes. In other words, it does not deal with the short-run.

Merit Pay

Merit pay is a reward based on how well an employee has done the assigned job. The payment is based on individual employee’s performance. Rewarding the best performer with merit pay is a powerful motivation. Merit pay motivates the employees to work hard and achieve the assigned tasks. Merit pay may be in the form of lumpsum amount or as a percentage base pay.

Some of the problems in designing a merit pay scheme are:

1. It is difficult to measure performance objectively.
2. Employees, very often, fail to understand the connections between merit pay and performance.
3. Bias in assessing performance.
4. The superior may not be a competent evaluator.

Scanlon Pay

The Scanlon Plan developed by Joseph Scanlon is designed to involve the workers in making suggestions for reducing the cost of operations and sharing the gains of increased productivity. The plan has two components, i.e., financial incentive aimed at cutting cost and increasing efficiency and suggestion scheme. The suggestion received from employees is screened and evaluated by a committee. If the suggestion is implemented and successful, the employees usually share 75% of the savings and the balance is set aside for the months in which labour costs exceed standard cost.

Profit Sharing Plan

Profit sharing involves the determination of organisation’s profit at the end of the financial year and the distribution of a percentage of the profits to employees, qualified to share the earnings. To enable the workers to participate in profit sharing, they are required to work a certain number of years and develop some seniority. Profit sharing is an additional payment over and above regular salary payment. Professional management consider workers as partners in the production process and profit is an outcome of the efforts of employees and therefore it could be shared between employer and employees.

According to ILO, “Profit sharing is a method of industrial remuneration under which an employer undertakes to pay to his employees, a share in the net profit of the enterprise in addition to their regular wages”.

According to Henry Seager, “Profit sharing is an arrangement freely entered into by which the employee receives a share fixed in advance of the profits”.

Features of Profit Sharing:

1. The proportion of the profits to be distributed is determined in advance.
2. The amount to be distributed depends upon the profits earned by the enterprise and is computed on the basis of agreed formula.
3. The employee should have some qualifications such as length of service to become eligible for the financial benefit.
4. Profit sharing is reward for collective efforts of employees and is over and above wages.
5. That are paid regularly.
6. The extra payment is generally paid in cash. However, it can be in kind such as equity shares,
7. Profit sharing may be on industry basis, locality, unit, department or individual basis also.

Objectives of Profit Sharing:

1. To develop employer-employee relations and employee morale.
2. To improve efficiency of operations by reducing costs and increasing output.
3. To eliminate waste in the use of materials and equipments.
4. To supplement the regular income of the workers.
5. To provide group incentive for higher output.
6. To provide for employee security in the case of death, retirement or physical disability.

Limitations of Profit Sharing:

1. The payment is made only when the profit exceeds a particular limit and therefore the scheme does not guarantee payment to workers.
2. During period of depression, it may not be possible for its management to make payment to worker.
3. It gives equal benefit to all workers and there is no distinction between good and bad performance.
4. Trade unions and workers feel that bonus payment is better compared to profit sharing.

ESOP

Employee Stock Plan is one of the important pay for performance devices to attract and retain promising employees. It commands employee loyalty. Stock options are tremendous motivators because they directly link performance to the marketplace. The principle of stock option is to let employee add value to the company and benefit from it.

It is a form of compensation which enables the employees to purchase shares of their company and gain from possible rises. Under the scheme, employees who are eligible for receiving the award are they offered specified number of shares. They gain when the share prices go up. Stock options create wealth for employees without involving large cash flow to the company.

Types of Employee Stock Plans:

1. Employee stock option scheme: The Company grants an option to its employees to acquire shares at a future date. The options are offered at a predetermined price.
2. Employee stock purchase plan is followed in listed companies: The employees are given the right to acquire share of the company immediately after they earn them based on length of service/performance, normally at a price lower than market price. Shares issued will be subject to lock-in period during which the employee cannot sell them.
3. Restricted stock plan: The employee need not put in money. However, shares are subjected to some restrictions. The employee has to continue to work in the company for a specific period, otherwise shares may be forfeited.
4. Phantom stock is a special type of stock option scheme that protects the holder against any depreciation in the value of stocks.

Advantages of Stock Plan:

1. Employee remains loyal and committed to the company.
2. Develops long-term relations between employer and employee. The employees feel that they are owners of the company and not just paid servants.
3. Develops teamwork among employees.
4. Reduces employee turnover.
5. The companies are able to attract and retain employees.
6. The scheme links compensation to performance.

Limitations:

1. The scheme can be implemented only by profit-making companies.
2. Falling share prices lead to losses.
3. Employees are forced to continue employment with the company for availing the scheme.

Gain Sharing

Gain Sharing aims at increasing productivity or decreasing labour cost and sharing the gains with employees. When productivity exceeds the baseline, an agreed savings is shared with employees. Gain sharing plan increases co-operation and understanding among workers and teams and they work for achievement of common goals. Example: Scanlon plan aims at cost cutting and increasing efficiency of operations and sharing the gains with employees. It also includes suggestion scheme for cost-cutting.

Earning at Risk plan

Earnings-at-risk (EAR) incentive plans are designed to enhance performance, in part, by creating base wage dissatisfaction that, in turn, triggers greater effort directed toward performance behaviors rewarded with incentive pay. However, employee disatisfaction with EAR plans in general and base wages in particular may also produce unintended consequences that counteract any benefits these plans produce.

Managers who decide to adopt an EAR plan should be aware of the negative reactions employees may have to these plans, the level of personal control employees actually have over targeted performance behaviors and the need for a level playing field that does not put newer employees at a disadvantage.

Prerequisites of an Effective Incentive System

• A good incentive plan should be simple, clear and easy to operate. An average worker should know the linkage of pay for performance.
• There should be active participation of workers and union while installing incentive plan.
• There must be a commitment on the part of the top management to the incentive program.
• The incentive plan should reward employees in direct proportion to increased productivity or quality.
• An incentive wage plan must be fair and equitable to both employers and the employees. It should be motivating to employees and economical to the management.
• The standards of performance and criteria for measurement should be fair, clear and aligned with firm’s strategy and objectives.
• There should be proper communication of details of the scheme to all the concerned persons.
• There should be a supportive environment from the employees for the scheme as any restriction can undermine the plan.
• The incentive plan should be in consistent with the corporate’ culture.
• The time gap between actual performance and reward should be as small as possible.
• There should be an atmosphere of mutual trust and understanding between employer and employee.
• A minimum wage rate should be guaranteed to every worker irrespective of his performance. It increases sense of security among workers.

A sound incentive plan should have the following essentials or requisites.

1. Simplicity: The incentive plan should be simple. It should be so simple that even an ordinary worker must be in a position to understand the contents of the scheme and must be able to calculate his earnings.
2. Plan should guarantee minimum wage: Incentive plan adopted must guarantee the minimum wage to all the workers irrespective of their working performance so as to ensure them a sense of security and confidence.
3. Worker’s Participation: Incentive plan should be accepted only after taking into confidence the workers and their union. Workers involvement ensures smooth flow of work.
4. Economical: The plan should be economical involving less clerical work. The benefit of the scheme should exceed the cost of operation of the scheme and plan should not involve elaborate records and complicated calculations.
5. Equitable: The plan should be fair, equitable and should cover all the employees. It must give equal opportunities to all workers to earn their wage incentives.
6. Clear understanding: The objectives of the scheme should be made known to all the employees so as to seek every employee’s co­operation.
7. Prompt payment: Wage incentives should be paid promptly whenever it has become due for payment. If the payment is delayed, workers may lose the faith in the scheme.
8. Conducive to workers health and safety: The plan should encourage the workers to earn adequate wages. The scheme should not over strain them which may tempt the workers to work hard to earn more which in the long run may affect on health of the workers.
9. Flexibility: The plan should give scope for making changes in accordance with the change in demand, market condition and government policy. Adjustability should be the glaring feature of sound incentive plan.
10. Fixation of Standard: For the purpose of payment of incentives, the standard fixed should be scientific and must be capable of reaching the standard by majority of workers without much strain.
11. Grievance Procedure: The plan should have effective grievance procedure to deal with complaints and dis-satisfaction of workers.
12. Performance Appraisal: There should be proper system of appraisal of the performance of employees so as to check the quality of output and to give guidance to the workers for improvement.

This theory was propounded by Walker. According to this theory, rent and interest are contractual payments. After deducting rent and interest from total product, the employer will deduct his profits. What remains after deducting rent, interest and profits is wages. It is possible to increase wages by increasing the total product by improving the efficiency of the workers.

This theory has several defects:

1. This theory assumes that the share of landlords, capitalists and entrepreneurs are fixed and it is absolutely wrong.
2. It is not the worker who is the residual claimant but the entrepreneur.
3. It does not explain the influence of trade union in wage determination.
4. The supply side of labour has been totally ignored by the theory.

Team-based incentive plans are initiatives designed to encourage and reward exceptional levels of professional achievement. You can use incentives in your small business as motivators for staffers to work collectively to earn monetary and non-monetary rewards. It is also a way for small business owners to boost overall productivity and earnings while simultaneously rewarding employees for a job well done. The objective of team incentives is to encourage group goal-setting, collaboration and teamwork.

Merit-Based Incentive

A more subjective approach to incentive programs is the merit-based incentive approach. Following this model, you reward employee teams for effort, regardless of outcome. For example, if your marketing employees stay late every night to finish a major advertising campaign that doesn’t perform as anticipated, their dedication and effort are still recognized. Because of the discretionary element of this type of incentive, it can be a challenge for employees to know what they aiming for or how they will know when their efforts or actions are viewed as “good enough” to merit reward.

Gain Sharing

Similar to a profit-sharing plan, gain sharing is a team incentive in which you reward employee groups for measurable, non-financial achievements in pre-established areas. For example, teams may enjoy a bonus if customer satisfaction levels rise a certain percentage above figures from the previous year. The focus of this type of incentive is for employees to recognize the role they play in continually moving your small business forward in key areas.

Goal-Based Incentives

Goal-based team incentives reward employees for reaching specific goals. For example, topping a certain dollar amount in sales, landing a specific number of contracts or hitting a membership recruitment figure. The approach encourages teamwork and gives employees a firm target to aim for. This incentive plan is good for small businesses because it promotes team work and collective effort, and you only issue the reward if the goal is met.

Profit Sharing

Profit sharing is a team-based incentive plan in which you pay your employees a percentage of your company’s overall profits. Profit sharing builds a sense of ownership among employees and encourages greater team performance levels. Staffers know that the better their performance, the better the business’s financial picture, and the higher their own potential cash rewards.

Financial vs. Non-Financial Incentive

It’s up to you, as the business owner, to decide what type of incentive you want to offer employee teams. If cash rewards are too much for your small business budget, other incentives to extend include paid time off, free company services or merchandise, or preferred parking or office space. Ask employees what they consider to be a viable and worthwhile reward and consider if it fits your budget.

Wages differ in different employments or occupations, industries and localities, and also between persons in the same employment or grade. One therefore comes across such terms as occupational wage differentials, inter-industry, inter-firm, inter-area or geographical differentials and personal differentials.

Wage differentials have been classified into three categories:

1. The differentials that can be attributed to imperfections in the employment markets, such as the limited knowledge of workers in regard to alternative job opportunities available elsewhere; obstacles to geographical, occupational or inter-firm mobility of workers; or time-lags in the adjustment of resource distribution and changes in the scope and structure of economic activities. Examples of such wage differentials are inter-industry, inter-firm, and geographical or inter- area wage differentials.
2. The wage differentials which originate in social values and prejudices and which are deeper and more persistent than economic factors. Wage differentials by sex, age, status or ethnic origin belong to this category.
3. Occupational wage differentials, which would exist even if employment markets were perfect and social prejudices were absent.

Type 1. Occupational Differentials:

These indicate that since different occupations require different qualifications, different wages of skill and carry different degrees of responsibility, wages are usually fixed on the basis of the differences in occupations and various degrees of skills.

The basic functions of such differentials are:

(a) To induce workers to undertake “more demanding”, “more agreeable or dangerous” jobs, or those involving “a great chance of unemployment, or wide uncertainty of earnings.”

(b) To provide an incentive to young person to incur the costs of training and education and encourage workers to develop skills in anticipation of higher earnings in future.

(c) To perform a social function by way of determining the social status of workers.

In countries adopting a course of planned economic development, skill differentials play an important role in manpower and employment programmes, for they considerably help in bringing about an adequate supply of labour with skills corresponding to the requirements of product plans.

Inter-occupational differentials may comprise skilled, unskilled and manual wage differentials; non-manual and manual (white and blue-collar); and general skill differentials. Occupational wage differentials generally follow the changes in the relative supplies of labour to various occupations.

Type 2. Inter-Firm Differentials:

Inter-firm differentials reflect the relative wage levels of workers in different plants in the same area and occupation.

The main causes of inter-firm wage differentials are:

(a) Difference in the quality of labour employed by different firms

(b) Imperfections in the labour market

(c) Differences in the efficiency of equipment, supervision and other non-labour factors.

Differences in technological advance, managerial efficiency, financial capacity, age and size of the firm, relative advantages and disadvantages of supply of raw materials, power and availability of transport facilities, these also account for considerable disparities in inter-firm wage rates. Lack of co-ordination among adjudication authorities, too, is responsible for such anomalies.

Type 3. Inter-Area or Regional Differentials:

Such differentials arise when workers in the same industry and the same occupational group, but living in different geographical areas, are paid different wages. Regional wage differentials may be conceived in two senses. In the first sense, they are merely a part of inter-industry differentials in a particular region.

“The industry mix varies from one area to another, and for this reason alone, the general average of wages would be expected to vary.” 22 In the second sense, they may represent real geographical differentials, resulting in the payment of different rates for the same type of work. In both cases, regional differentials affect the supply of manpower for various plants in different regions.

Such differentials are the result of living and working conditions, such as unsatisfactory or irksome climate, isolation, substandard housing, disparities in the cost of living and the availability of manpower. In some cases, regional differentials are also used to encourage planned mobility of labour.

Type 4. Inter-Industry Differentials:

These differentials arise when workers in the same occupation and the same area but in different industries are paid different wages. Inter-industry differentials reflect skill differentials. The industries paying higher wages have mostly been industries with a large number of skilled workers, while those paying less have been industries with a large proportion of unskilled and semi-skilled workers.

Other factors influencing inter-industry differentials are the extent of unionisation, the structure of product markets, the ability to pay, labour-capital ratio, and the stage of development of an industry.

Type 5. Personal Wage Differentials:

These arise because of differences in the personal characteristics (age or sex) of workers who work in the same plant and the same occupation. “Equal pay for equal work” has been recommended by the I.L.O. Convention (No. 100), as also by Industrial Courts, Labour Tribunals, the Minimum Wages Committee and the Fair Wage Committee. But in practice this principle has not been fully implemented because in occupations which involve strenuous muscular work, women workers, if employed, are paid less than men workers.

Lack of organisation among women employees, less mobility among them, their lower subsistence and their weak constitution are other reasons which bring them lower wages than their male counterparts receive.

Wage differentials that show the differences in the rate of wages among workers working in the same unit, different units, different occupations, different regions and the like have emerged as a common feature of labour markets in various countries.

Wage differentials bear a direct relationship to the diversity in occupation and industries that exist in the economic sphere of activity in a country. A certain job requiring a certain skill is paid more or less than another job requiring a different skill either in the same or some other industry. There are a variety of contributory factors.

Wage differential refers to differences in wage rates due to the location of company, hours of work, working conditions, type of product manufactured, or other factors. It may be the difference in wages between workers with different skills working in the same industry or workers with similar skills working in different industries or regions.

We will get different terms as occupational wage differentials, inter-industry, inter-firm, inter-area or geographical differentials and personal differentials because wages differ in different employments or occupations, different industries and localities, and even between the persons in the same employment or grade, etc.

If it is depressed, this will have some effect on wages and consequently on the grades. The rate of dearness allowance (DA) depending on the index chosen will affect wage differentials. In many situations, arbitration or judicial pronouncements have favored a higher quantum for the lowest category of workers.

On a wide scale, there has not been a systematic attempt at job evaluation – an exercise which would have identified the differences in terms of skill training experience, etc. between jobs and provided for relative weightages which could lead to standardization and eradication of distinctions for the same type of jobs.

In the modern organized sector, where collective bargaining is prevalent, there is a trend towards job evaluation schemes. The influence of collective bargaining in terms of pushing up wages in some industries and regions has been quite significant, especially in situations where collective bargaining is coupled with union strength.

Finally, the difference in terms of a unit’s level of productivity and profitability and its influence differentials has to be considered. If both productivity and profitability are high, then the wages sought and given are correspondingly bound to be high.

Salary Differentials and Economy Functions:

Salary differentials perform important economic, functions like labour productivity, attracting the people to different jobs. Since most of the workers are mobile with a view to maximising their earnings, wage differentials reflect in variations in productivity, efficiency of management, maximum utilisation of human force etc.

Attracting efficient workers, maximisation of employee commitment, development of skills, knowledge, utilisation of human resources, maximisation of productivity can be fulfilled through wage differentials, as the latter determines the direct allocation of manpower among different units, occupations and regions so that national production can be maximised. Thus, wage differentials provide an incentive for better allocation of human force, labour mobility among different regions and the like.

Salary differentials play pivotal role in a planned economy in the regulation of wages and development of national wage policy by allocating the skilled human force on priority basis. Development of new skills, knowledge etc., is an essential part of human resource development.

Shortage of technical and skilled personnel is not only a problem for industries but it creates bottlenecks, in the attainment of planned goals. Thus, wage differentials to certain extent, are desirable from the view point of national interest. As such, they probably become an essential part of national wage policy. Complete uniform national wage policy is impracticable and undesirable.

This theory was developed by J.S.Mill. According to him, the employers set apart a certain amount of capital to pay wages for labourers. This is fixed and constant. This is called as wages fund. Wage is determined by the amount of wages fund and the total number of labourers.

According to J.S.Mill, “wages depend upon the demand and supply of labour or as it is often expressed as proportion between population and capital. By population is here meant the number only of the laboring classes or rather of those who work for hire and by capital, only circulating capital………. “.

Wage rate = Wage fund / Number of labourers

An increase in wage rate is possible only by an increase in wage fund or by a reduction in the number of labourers. Thus there exists a direct relation between wage rate and wages fund and inverse relation between wage rate and number of labourers. This theory also states that trade unions are powerless in rising the general wage rate.

Criticisms:

1. Wage fund theory states that the wage rate is found by dividing the wage fund by the number of workers. But it does not tell us about the sources of wages fund and the method of estimating it.
2. Wage fund theory is unscientific and illogical because it first decides the wages fund and then determines wages. But in reality, wages should be found first and from that wage fund should be calculated. This theory neglects the quality and efficiency of the workers in determining the wage rate. This is considered to be a basic weakness of the theory.
3. This theory neglects the quality and efficiency of the workers in determining the wage rate. This is considered to be a basic weakness of the theory.
4. This theory assumes that wages can increase only at the expense of profit. This is not correct. The operation of the law of increasing returns will lead to a great increase in total output which may be sufficient to raise both wages and profits.
5. The wages fund theory has been criticised by the trade unions for its assumption that wages cannot be increased through bargaining.
6. Wages fund theory has failed to explain the differences in wage rate.
7. This theory believes that wages are paid out of circulating capital. But when the process of production is short, wages are paid out of current production. When the process of production is long, wages are paid out of capital.