Friday, April 27, 2012

Why did Henry Ford pay better wages?

[response to Minimum-wage Misconceptions over at Salon.com, wherein I put on my Pretend Economist Hat.]

Nice article, but I do want to say something about Henry Ford. I've often heard this motivation dismissed as mythical: Ford did not raise wages in order to create demand for automobiles within his company.

I suspect that's true, because when you look at the economics of such a move, it doesn't make any sense. First, there's nothing stopping your workers from spending the wage increase on the many things that aren't automobiles. Second, there's nothing stopping them from buying their autos from your competitors. Finally, even if you ignore those (huge) problems and assume that every dollar you send out in increased wages is applied to the purchase of one of your cars, you're still losing money hand over fist. If your profit margin on an auto is 20%, then for every dollar you put into raising wages, you can't get more than twenty cents back.

If Ford's goal was to use that money to increase demand for automobiles, it would have been much more sensible to use it to lower the selling price of his cars.

Ford's real motivation in raising wages, as I understand it, was to reduce employee turnover, and also to act as a bonus in exchange for some demands that he put on his employees that his competitors didn't (no alcohol, no gambling, learn English).

So if you're a single company, who mostly sells its products to people outside the company, raising is a losing strategy for boosting demand.

But raising wages does make a lot more sense when discussing a national economy, where most of the goods and services being sold are sold to your fellow citizens. In that case, most of the money a company loses in the form of higher wages will come back to it in the form of increased demand for their products.

2 comments:

Anonymous said...

If Ford knew that raising somebody's salary by $1 would only cost him $0.90, then it makes sense that he would offer higher wages all else being equal. Any benefit which costs an employer less than the utility enjoyed by the employee will make up a disproportionate amount of compensation. See health care coverage, employee discounts, etc.

In order to change actual wages, you need to modify the bargaining positions of the parties. If the employer is in a strong bargaining position, they will tend to claw back any official gains one might make by raising wages. It makes much more sense to arrange things so employers have reduced strength as a bargaining position (lower unemployment to near NAIRU).

Bryce said...

I think you're actually arguing my point for me. It would be far cheaper to offer employee discounts for cars rather than just raising salaries. Using your numbers, maybe paying $1 extra in the form of salary might recoup 10 cents to the employer (as Ford could expect some of that money would be used to buy his cars), but an employee discount on cars would probably recoup probably 40 or 50 cents of the face value of the discount.