February 21, 2013 - In a Financial Post op-ed today, MLI's Research Co-ordinator Philip Cross says there are several things wrong with the simplistic analysis that increasing workers' pay boosts purchasing power and economic growth. He uses the premise that Ford raised wages to increase purchasing power to explain why. Read his full op-ed below.
Ford's productivity leap made his wage hike possible
By Philip Cross, Financial Post, February 21, 2013
Fortune magazine recently ran an article based on its book The Greatest Business Decisions of All Time. Making the cut — it is promoted on the book's cover — was Henry Ford's famous decision to double workers' pay to US$5 a day, ostensibly so "workers could now afford the very products they were producing," in the words of Fortune. Sort of "employee pricing," but done through higher wage scales, not lower prices. The Ford website today still cultivates this myth, claiming the wage increase "helped build the U.S. middle class."
The idea is regularly floated that firms should pay more to boost purchasing power and economic growth. Just last week, a union leader in the U.S. retail industry said: "Wal-Mart could provide the nation with a much needed economic boost by paying higher wages." There are several things wrong with this simplistic analysis.
Start with the premise that Ford raised wages to increase purchasing power. As the Fortune article documents, before raising wages, Ford already had doubled output of the Model T with his innovative use of the moving assembly line, without adding to employment. The moving assembly line is what Ford deserves accolades for. To get an idea of how revolutionary it was, Ford built just over a quarter of a million cars in 1914, as much as the rest of the industry combined, but with 80% fewer workers. In other words, productivity already had doubled, allowing Ford to double wages without increasing labour costs.
And he needed to raise wages. Employee turnover at the Highland Park Model T assembly plant hit 370% in the year before the wage increase, clearly symptomatic of a dysfunctional internal labour market. That means Ford incurred the cost of hiring 52,000 people in 1913 to fill 14,000 jobs. The real reason Ford hiked wages was to reduce the cost of this turnover, not a soft-hearted desire to transfer purchasing power from management Scrooges to the Cratchits of the world.
The plan worked like a charm, as turnover plunged to 16% after wages were doubled, reducing labour costs despite the wage hike. Saying he did it to raise purchasing power was just good public relations. Who wants to advertise that their workplace was so disagreeable they could not keep workers for more than a few weeks at a time?
The motive never was to subsidize sales of the Model T to his 14,000 workers, a pittance compared with total Model T production of nearly 200,000 in the first year of the new pay scale (and 15 million by the end of its production in 1927). Ford boosted sales by cutting car prices nearly 50% between 1912 and 1916 while booking higher profits. It was the radical innovation of the assembly line that allowed everyone to win: workers received increased wages, the firm generated higher profits, while consumers paid lower prices.
Ford is still reaping good publicity from the notion its founder spread joy and good cheer in the workplace by raising wages. Its website marvels that "newspapers from all the world reported the story as an extraordinary gesture of goodwill." The universal appeal of this fable, repeated today by gullible journalists like those at Fortune, is probably because it feeds everyone's fantasy that one day you'll show up at work and get that long overdue raise, without your firm compromising its competitive position.
Hogwash. If most firms doubled their employee's wages without an offsetting increase in productivity, they'd go bankrupt overnight. Moreover, the $5 a day came with conditions few would accept today. Some of it was a bonus if workers stayed for six months and met the strictures of the Social Department and its 50 investigators, including avoiding alcohol and gambling and taking English lessons.
Over the long haul, Ford may have come to believe too much in his public personae as the High Wage Fairy. You can connect Ford's pronouncements about the benefits of not "making a few slave drivers in our establishment millionaires" with the inflated wages received at the end of the century by autoworkers and ultimately the bankruptcy of GM and Chrysler (Ford survived largely due to a timely US$10.1-billion line of credit taken out in 2007).
The video clips of tens of thousands of workers lined up for a few hundred auto jobs in the mid-1990s were a clear sign that the dysfunctional amount of labour turnover at Highland Park had come full circle, with extravagant employee benefits beckoning legions of workers from other sectors. A lower wage scale for new hires since 2009 marks the beginning of the correction to this imbalance.
Commentators regularly mix sentimentality with economics when discussing wages. The point is that the inherent goodness or well-meaning of people in a particular line of work is irrelevant, as is aggregate purchasing power. Supply and demand ultimately determine wages.
Philip Cross is research co-ordinator for the Macdonald-Laurier Institute and the former chief economic analyst at Statistics Canada.