Different Theories for Managing Compensation

The basic purpose of wage and salary administration is to establish and maintain an equitable wage and salary structure. Its secondary objective is the establishment and maintenance of an equitable labor-cost structure i.e., an optimal balancing of conflicting personnel interests so that the satisfaction of employees and employers is maximized and conflicts are minimized. The wage and salary administration is concerned with the financial aspects of needs, motivation and rewards. Managers, therefore, analyze and interpret the needs of their employees so that reward can be individually designed to satisfy these needs.

The word ’salary’ is defined in the Oxford Dictionary as ‘fixed periodical payment to a person doing other than manual or mechanical work’. The payment towards manual or mechanical work is referred to as wages. The word pay refers to the payment for services done which would include salary as well as wages.

Wages are commonly understood as price of labor. In ordinary parlance, any remuneration paid for services is etymological wage. Benham defines wage as “‘a sum of money paid under contract by an employer to a worker for services rendered.”

Labor was always looked upon as a commodity governed by the law of supply and demand. Certain theories were propounded for determination of wages but these could not stand the test of time. A few theories are discussed below:

  • Subsistence theory: This theory, also known as ‘Iron Law of Wages’, was propounded by David Ricardo (1772-1823). According to this theory, wages tend to settle at a level just sufficient to maintain the workers and his family at minimum subsistence levels. The theory applies only to backward countries where laborer’s are extremely poor and are unable to get their share from the employers.
  • Standard of living theory: This theory is a modified form of subsistence theory. According to this theory, wages are determined not by subsistence level but also by the standard of living to which a class of laborer’s become habituated.
  • Residual claimant theory: Francis A. Walker (1840-1897) propounded this theory. According to him, there were four factors of production/ business activity viz., land, labor, capital and entrepreneurship. Wages represent the amount of value created in the production which remains after payment has been made for all these factors of production. In other words, labor is the residual claimant.
  • The wage fund theory: According to this theory, after rent and raw materials are paid for, a definite amount remains for labor. The total wage fund and the number of workers determine the average worker’s share in the form of wages.
  • Demand and supply theory: According to this theory, wages depend upon the demand and supply of labor.
  • Marginal productivity theory: This is an improved form of demand and supply theory. Wages are determined by the value of the net product of the marginal unit of labor employed.
  • Purchasing power theory: According to this theory the prosperity, productivity and progress of industry depend on there being sufficient demand to ensure the sale of its products and pocketing of reasonable profits. A large pact of the products of industry is consumed by workers and their families and if wages are high, demand will be good. However, if wages and the purchasing power of the workers are low, some of the goods will remain unsold; output will go down, which will result in unemployment.
  • The bargaining theory of wages: John Davidson propounded this theory. According to him, wages are determined by the relative bargaining power of workers or trade unions and of employers. When a trade union is involved, basic wages, fringe benefits, job differentials and individual differences tend to be determined by the relative strength of the organization and the trade union.

The Tribunals and Wage Boards have generally followed the-principles laid down in the Fair Wages Committee’s Report on fixing wages. The Committee, in its report, has given a considerable thought to wage differentials and has stated that the following factors should be taken into consideration for fixation of wages:

  1. The degree of skill.
  2. The strain of work.
  3. The experience involved.
  4. The training involved.
  5. The responsibility undertaken.
  6. The mental and physical requirements.
  7. The disagreeableness of the task.
  8. The hazard attendant on the work, and
  9. The fatigue involved.

N.B: Classification of wages: The International Labor Organization (ILO) in one of its publications, classified wages as under:

  1. The amount necessary for mere subsistence;
  2. The amount necessary for health and decency; and
  3. The amount necessary to provide a standard of comfort.

In India, wages are classified as:

  • Minimum wage
  • Fair wage; and
  • Living wage

Minimum wage: A minimum wage has been defined by the Committee as “the wage which must provide not only for the bare sustenance of life, but for the preservation of the efficiency of the worker. For this purpose, the minimum wage must provide for some measure of education, medical requirements and amenities”. In other words, a minimum wage should provide for the sustenance of the worker’s family, for his efficiency, for the education of his family members, for their medical care and for some amenities. It is very difficult to determine the minimum wage because conditions vary from place to place, industry to industry and from worker to worker. However, the principles for determining minimum wages were evolved by the Government and have been incorporated in the Minimum Wages Act, 1948, the important principle being that minimum wages should provide not only for the bare sustenance of life but also for the preservation of the efficiency of the workers by way of education, medical care and other amenities.

Fair Wage: According to the Committee on Fair Wages, “it is the wage which is above the minimum wage but below the living wage.” The lower limit of the fair wage is obviously the minimum wage; the upper limit is set by the “capacity of the industry to pay”. Between these two limits, the actual wages should depend on considerations of such factors as:

i) The productivity of labor;

ii) The prevailing rates of wages in the same or neighboring localities;

iii) The level of the national income and its distribution; and

iv) The place of industry in the economy.

Living Wage: This wage was recommended by the Committee as a fair wage and as ultimate goal in a wage policy. It defined a Living Wage as “one which should enable the earner to provide for himself and his family not only the bare essentials of food, clothing and shelter but a measure of frugal comfort, including education for his children, protection against ill-health, requirements of essential social needs and a measure of insurance against the more important misfortunes including old age”. In other words, a living wage was to provide for a standard of living that would ensure good health for the worker, and his family as well as a measure of decency, comfort, education for his children, and protection against misfortunes.

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