Which Came First: Profits or Wages?

by Richard Morris

I find it no surprise that Karl Marx, founder of the political theory of Communism that has killed hundreds of millions of innocents over the last century, and Speaker of the House Nancy Pelosi say the same things.

For example, on September 17, 2021, Speaker Pelosi said:

In America, capitalism is our system, . You cannot have a system where the success of some springs from the exploitation of the workers.

Marx's "surplus value" theory says the difference between the sales revenue  and the wages paid to make the product (profit) is surplus value. Thus, Marx says the employer steals profit by exploiting the worker, who should receive it as higher wages. It sounds to me like Pelosi says the same.

But - which came first, profit or wages?

Let me define the terms. A wage is money paid by an employer to an employee for work. Profit is the income received, minus the cost of production and sales.

Now, let's consider a widget maker - we'll call him Mr. Wow. Working alone, the revenue exceeding his cost of production is profit. Yes, profit, one of the most evil words in the Marxian lexicon. But wait: Wow has no workers to pay, ergo, no wages at all.  Everything he earns is "excess" profit, but it's excess to him, since he did all of the work; he keeps it all.

However, working alone, Mr. Wow can make only a certain number of widgets. Now, let's suppose customers want (demand) more widgets than Wow can make. In that case, one way he can increase production, and thus the supply of widgets, is to hire an assistant to help him. But there is no benefit for Wow to create a job and hire help unless it will increase his profit.

If he hires a helper, the wages are part of the cost of production. They will come from the revenue of the additional widgets sold.

Remember, before he hired somebody, there were no wages. Now he has a paid employee. Could Wow's increased profit be stolen from the employee, as Marx claimed?

The greater the demand for widgets, the more is Wow's demand for workers. Wow creates jobs. Wow is the prime mover of the business, not the workers. The workers cannot be the prime movers because neither the company nor their jobs would exist without Mr. Wow - again, contrary to Marx.

As Wow's widgets catch on, he needs to make even more. So, to make his workers more efficient, Wow buys widget-making equipment and a building to manufacture them. This is called capital, and Wow becomes a capitalist, an evil person in Marx-speak.

The Marxists shout that the employer is at war with his workers. But take a look: there's no war! They work together. Wow's workers were not forced to work; they wanted to. And Wow voluntarily hired them.

The workers benefit by receiving wages, Wow benefits when gross revenues exceed expenses by more than he could do alone, and the customers benefit by having an increased supply of widgets. Everybody is happy.

Too simple, say the politicians. Marx claims an antagonistic struggle between the capitalist and worker determines wages. So they beat the war drums for laws allegedly to meet the needs of workers and force greedy employers to pay what the drummers consider a proper wage. But could it be these claims are both untrue and irrelevant? Let's see.

To live, people must consume stuff, and somebody has to make that stuff. If a worker had no alternative, the worker must either work for a subsistence wage or die. This led Marx to predict employer greed would drive wages down so low that they would only be enough to keep workers alive so they could work as slave labor.

Is this what we've seen in the world since the days of Marx?  Absolutely not. Not only was Marx utterly wrong, but his whole concept of surplus value is not relevant to actual wage rates.

Of course, employers prefer to pay lower wages than higher wages. Employers are buyers of labor, and every buyer wants to pay less for whatever he is buying. But so what? The naked desire to pay less does not set the price of anything - including wage rates.

Here's why. Assume there are two potential buyers, and both want the same widget. Both buyers wish to pay the least possible. Buyer One is willing to bid up to $200. The other, Buyer Two, has a limit of $100.

Buyer One is willing to bid $200, but does that mean he wants to? Of course not - he wants to buy for the lowest price he can. So the question is: how low can Buyer One go and still end up with the widget? $20?

If you answered no, go to the head of the class. If, for example, Buyer One offers $20, the widget will go to somebody bidding more than $20, and we know Buyer Two's limit is $100. So if Buyer One wants to buy the widget, the winning bid will end up higher than Buyer Two's maximum of $100.

That's how things work in real life. A buyer cannot pay the price he would like to pay, but must pay a price equal to or higher than other potential buyers. So in this example, since Buyer One's limit is $100, Buyer Two must outbid him. Thus the market price is $101.

The only difference between the labor market (wages) and the widget sale is the number of units involved; the principle is the same. Instead of one widget with two buyers, millions of workers want to sell their services, and millions of employers want to buy them.

There is an infinite number of things to do. We call them jobs. Therefore, the number of jobs available (demand) exceeds the number of workers who want to do those jobs. In economic terms, this is called a limited supply. Whether workers will take one job or another depends upon the price, i.e., the wage rates.

How low can wages go? Marx argued that wage rates decrease to the point of subsistence - as usual, he was wrong.

Moreover, the competition among employers causes wages to increase, not decrease. Three hundred years of history well demonstrates that real wages increase as worker productivity increases. This is precisely contrary to Marx's claim that capitalism results in continuously lowering wages. Here's the rule: in a free market, wages can go no lower than the point of full employment.

What does that mean? Let's look at the mysterious full employment point. Full employment means all available workers have jobs. But, whatever the wages are at full employment, that is as low as they can go. Any employer who offers less will have no applicants for the job and risks his present workers quitting to go to employers offering more. This "market force" raises wages to the "full employment" wage rate.

In other words, even if workers are willing to work for minimum subsistence, the wage they will actually get depends solely on the market, not the workers' need or the employers' greed. Need and greed are not relevant because the interactions of buyers and sellers determine prices, including wage rates.        

Let's return to the simplified widget industry. We find Wow's Widgets and its competitor Wonder Widgets are the two buyers of labor, the "greedy" employers who seek a worker. Both want to pay the lowest price (wages) for the worker's work. But on the other hand, the greedy worker (the seller) wants to sell his skills at as high a price as he can get. Does this create a Marxist antagonistic struggle between them?

No. We already know employers must pay wages high enough to attract and keep the workers they want. Therefore, Wow's Widgets must bid more than Wonder Widgets to attract and retain the workers.

The economy is not a fixed pie. By that, I mean if Person A becomes rich, that doesn't mean less income for Persons B and C. Moreover, successful entrepreneurs only get a tiny fraction of their wealth from creating jobs for others. Lastly, you don't have to be an economist to see the average income keeps rising, and all segments of society tend to rise and fall together.

To recap, first, both "worker need" and "employer greed" are not relevant to how much wages are paid. Second, profits do not come from wages because profits precede wages.

Contrary to Marx and Pelosi, the successful capitalist creates jobs and provides the path to wealth for many workers.  Get rid of the profits, as Marx and Pelosi want to do, and you'll get rid of the capitalists, as well as the countless millions of jobs they create every day.

Wouldn't it be easier to just get rid of one job, Nancy Pelosi's?