Von Thunen – Wages and Interest

Johann Heinrich von Thünen, Wages and Interest: Surplus

Von Thunen was seriously concerned over what we call "the labor problem," and to its solution he devoted a large part of his later study. For over twenty years after the publication of his first volume in 1826, he centered his thought upon the relation between interest and wages, and particularly upon the relation between capital and the product of labor.

Putting the question, Are low wages "natural" or are they due to usurpation by capitalists? he answers, The latter. What, then, is the natural wage? That is, what ought wages to be? Here, he says, the economists do not help us to an answer. They merely state a truism: wages are determined by demand and supply, and are what they are. This does not satisfy one who, like von Thunen, sees in wages the means of livelihood for men and women rather than a mere price set by competition upon the commodity, labor. He says that Smith had done well for his time, but that, in view of the discontent and danger of class conflict which had since arisen, economists must go further.

Von Thunen, accordingly, seeks to get at the bottom of the problem by first simplifying it. He goes to the margin of cultiva­tion, thus eliminating rent. He assumes a tabula rasa. He then reduces capital productivity to labor productivity. In so doing, he implies that capital is stored-up labor, his procedure being to divide laborers into two classes, (1) the capital-producing and

(2) the mere subsistence-producing. He then proceeds to determine wages (and interest) for the first class, on the assump­tion that competition will give the same wage as to the latter class.

It is to be noted in advance that von Thiinen had the idea that successive units of labor and capital yield less than pro­portionate returns, and that consequently there are surpluses above the returns on the last units, in which surpluses labor should share. The evil of low wages lies in the fact that capital retains more than its share. It is necessary, then, to ask: what is the natural interest rate, and can the existing rate be en­croached upon?
Now with this idea in mind, and reasoning under the above assumptions, von Thünen seeks in four ways to analyze the relation between wages and interest, and to derive a law for determining the natural or proper wage (and interest): he con­siders (1) capital as produced by labor, or labor as producing capital; (2) labor as replaced by capital (i.e., substitution);

(3) marginal productivity of capital; (4) marginal productivity of labor.

From the first point of view, he makes the interest on a given capital depend upon the amount of labor — or rather the amount of subsistence for labor — required for the pro­duction of that capital. The formula is: interest is to capital, as the (additional) income secured by the laborer as a result of his producing the capital is to the wages of the laborer. Accord­ing to this idea, "natural" wages (and interest) would vary with productivity.
These conclusions must also apply to non-capital-producing laborers; otherwise they would take to producing capital. As von Thunen puts it, the excess of wages over subsistence must, at interest, equal the income secured by capital-producing laborers. In a word, under von Thunen's assumptions, the additional income received by capital-producing laborers from the productivity of their capital would be a determining factor
in all wages.

As to the third and fourth points of view, von Thunen's reasoning is based upon two advanced concepts: (1) a univer­salized law of diminishing returns; (2) a marginal productivity analysis of distribution. Briefly put, his idea on the third point is that as successive units of capital are added to a given indus­try or undertaking, the return diminishes in quantity and net value; that is, additional capital increases the productivity of a nation's labor at a lower rate than earlier portions. More def­initely, successive units of capital added to a given amount of labor on marginal land result in a decreasing product per unit (p. 101), and the return upon the whole supply of capital, when lent, is determined by the use of the last bit of capital applied. Thus, as already suggested, a surplus value arises in the use of the earlier units. This surplus above the marginal unit "nat­urally" belongs to labor.

From the fourth point of view, he considers wages as deter­mined by the marginal productivity of labor. He illustrates by imagining additional labor put upon a given potato field, and presents a table indicating decreased returns. His conclusion is that the last laborer employed receives what he adds, and that his wage determines the rate for all laborers of equal skill and capacity. From this point of view, there is also a surplus: "Even if the last-added laborers do not produce more than enough to cover their wages, yet the preceding laborers afford a very considerable surplus to the undertakers, which gives them the means of paying a higher wage."

On all four bases, von Thunen professes to reach the same conclusion, namely, that the "natural wage" is indicated by the formula √AP , in which A equals the value of the product of labor and capital, and P equals the subsistence of the laborer and family.

The general idea is clear. A surplus arises on the earlier units of an investment of successive increments of labor and capital. Subsistence must be considered as a minimum; but labor ought to have more than a bare subsistence, and ought to share in progress. How, then, shall this surplus be shared? Give labor a share which will vary as the square root of the joint product of the two factors. This would remove the fatal clash of interests between labor and capital, and as long as a laborer got such a wage he would never be in need, —• a fact of "decisive importance" (p. 208). Needless to say, the above idea of margin and surplus anticipates ideas commonly associated with more recent developments in theory.

In brief criticism, it must be remarked, however, that the foregoing idea of a surplus well illustrates a vicious tendency of the so-called "dosing method" of reasoning in economics. In reality, no such distinction between the value product of one group of laborers and that of another, increased by the addition of more laborers, exists. There is no such separation between the two cases as von Thunen's theory implies. One cannot logically assume that in the first case a group of men got certain wages, and then, when additional ones were employed and brought wages down, that the difference between the two wage rates would be left as a surplus in the hands of the em­ployer. Rather the difference ceases to exist as soon as the new arrangement is effected, and the "surplus" is merely an his­torical thing. In the larger group, the laborers do not produce as much on the average as they did. Simply, conditions as to the relative proportions of land, labor, and capital have been altered, and, other things being equal, the average laborer is less produc­tive.

To his wages formula, von Thunen attached an exaggerated significance, even expressing a wish that it should be engraved upon his tombstone, though his correspondence shows that in later years he felt the impossibility of applying it, and for practical purposes he suggested the use of a sort of profit-shar­ing scheme.

In fact, the formula has no exact validity. So varied is the part played by labor, relatively to capital, in different industries or in different stages of the same industry, that no such formula can express the share of the total value product attributable to it in general. Here, at least, this great economist fell victim to his abstract method and his disposition to reduce economic principles to mathematical formulae. His formula would do under certain limitations, as under an assumption of the dom­inance of economic motives, of free land, equal opportunity, no capitalist class and little capital, and equal laborers. But as a scientific law explaining the causation or governing the deter­mination of wages, it has no general validity. At most, it can be taken to express the rather obvious truth that the wage ought to lie somewhere between subsistence and total product — or, perhaps, the hope that wages may be above "subsistence."

One cannot but be reminded of Ricardo's difficulties in dealing with different proportions of fixed and circulating capital in working out his attempt at a labor theory of value. In any such attempt, the proportions of labor and capital must be known, which is but another way of stating that capital is more than stored-up labor, as such. There is another element of cost, or time, involved, which makes the application of the labor-pain or labor-subsistence value solvent impossible. In this Senior was wiser than von Thunen.

But one must not forget the great truths which accompany the error. The emphasis of the humanitarian and ethical as­pects of the labor problem, while not primarily an economic matter, is important for the application of theory. Von Thunen did well, too, in calling attention to the productivity aspect and in criticizing others for dealing only with subsistence and supply of labor.

The breadth of his thought is illustrated by another criticism which he incidentally passes upon the economists. These, he says, had written as though land were the only productive factor to be economized. While it is true that the total supply of land is limited in a sense, yet there are places where it is abun­dant and labor is scarce, as in North America. Economic theoRY should be broad enough to accommodate all relations. As al­ready implied, von Thunen is the father of an idea of diminishing returns that is broad enough to be applied to all the factors.