It’s a commonplace in the political debate that if only companies would pay their workers higher wages then everything would be so much better. Currently applied to WalMart, the poster child historically for the argument, has been Ford’s decision in 1914 to raise the wages for its assembly line workers from $2.43 for a nine-hour day to $5 for an eight-hour one. This enabled autoworkers to afford the products of their own company and thus made Henry Ford his fortune. Here’s a typical exposition of that argument:
This practice may sound like prudent business, but in fact it is a reversal of the insight by Henry Ford that built the middle class and set the foundation for America’s prosperity in the twentieth century: that by paying workers well, companies created a virtuous circle, since better-paid staff would consume more goods, enabling companies to hire yet more worker/consumers.
The only slight problem with this idea, appealing as it is, is that it isn’t remotely true. If we believe these numbers (and I see no reason why we shouldn’t) the increase in wages would have meant almost no discernible difference in demand for Ford’s cars. In 1914, the year of the pay rise, Ford had 13,000 workers and they produced 260,720 cards between them. Even if all 13,000 of them bought a car each (which of course they didn’t, at least not every year they didn’t) it really wasn’t going to have much impact on sales.
The real reason for Ford’s wage rise was to limit the job churn, the number of workers he had to recruit and train each year.
Over the course of 1913, the company had to hire 963 workers for every 100 it needed to maintain on the payroll. To keep a workforce of 13,600 employees in the factory, Ford continually spent money on short-term training. …..Between 1914 and 1916, the company’s profits doubled from $30 million to $60 million. “The payment of five dollars a day for an eight-hour day was one of the finest cost-cutting moves we ever made,” he later said.
The move had absolutely nothing at all to do with “creating a middle class,” nor developing the larger American economy. It was purely and simply a direct move to reduce training costs so as to increase the bottom line.
And there’s another lesson in this to: raising your wages so as to reduce your training costs does work, but only if everyone else doesn’t do it too. Think of it this way. If you and the other employers around are bottom feeding, offering the least you can get away with and still have live workers turning up most mornings, then of course you’re going to have unhappy staff, staff who will move away to another employer at the first sniff of a slightly better deal. Thus the high job churn.
If you’re the only employer in town that offers high wages and good benefits then you will indeed get the pick of the crop of the workers available. And they’ll stay with you because no one else is offering them the same return for their labor. This of course lowers your labor acquisition and training costs. But what happens if everyone in town is offering the same higher levels of wages and benefits? We’re back to the same original equilibrium, workers happy to flit around from company to company in pursuit of marginal gains, just that everyone is now at a higher pay level.
So the benefit to companies of paying these higher wages is only there if they are the only, or one of the very few, that do indeed offer those higher wages. Once everyone does, the benefits disappear.
Which rather brings us back to WalMart and the argument, from their point of view, against raising the wages of their workers:
The argument is that this pattern is good for the laboring classes, since Wal-Mart can sell goods at lower prices, providing savings to lower-income consumers like, for instance, its employees. The logic is specious: Wal-Mart’s workers spend most of their income on goods and services they can’t buy at Wal-Mart, such as housing, health care, transportation, and gas, so whatever gains they recoup from Wal-Mart’s low prices are more than offset by the rock-bottom pay.
Just as the vast majority of the rise in wages that the Ford workers got was not spent upon Model Ts, so any pay rise given to WalMart workers would be a direct cost to the company and would hardly, if at all, increase their sales.
So can we please put to rest this absurd idea, that Ford’s $5 work day was the beginning of middle class America? That it would be in the self-interest of all companies to simply pay their workers more? It simply isn’t true and we’re deluding ourselves if we think that it is.
In the long term (certainly, with blips around the trend like we’ve had over the past few years) there’s one thing and one thing only which raises the workers wages and that’s rising productivity. Raise that and companies will bid up wages, just as Ford did, in order to profit from the higher output gained from each hour of each worker’s labor. And the reason they’ll do that is that their competitors will also be vying with them for access to the same profit producing resource.
Tim Worstall is an Englishman who has failed at many things. Odd bits and pieces of his writing have been known to turn up in the Times, and the book pages of the Daily Telegraph