David R. Henderson  

Adam Smith on Ford's $5 a Day

Russ Roberts and Dan Pink... Dodd-Frank-Enron...

Don Boudreaux has an excellent post taking on the myth that one reason Henry Ford paid the huge (at the time) daily wage of $5 was that he wanted workers to have more money to buy his cars. Don gives an alternate explanation: that Ford wanted to reduce turnover. He leaves out, however, the main reason why paying workers more so they can buy your product makes no sense. As Don points out, Tim Worstall supplies the missing reasoning. Worstall's key paragraph:

That year [1913, when he introduced the $5 wage] his establishment of workers was some 14,000 head: his sales some 170,000 and that's just the year that he started ramping up production through the moving assembly line (reaching 500,000 in a couple of years and near a million within a decade). The spending power of his workforce was entirely marginal.

Worstall also points out that the $5 bonus was not strictly a daily wage but was half pay and half bonus. And the bonus was conditioned on other behavior.

But back to the issue of paying workers more so they'll buy your product. Adam Smith made the same point in another context in The Wealth of Nations. In his discussion of why imperialism doesn't make sense economically, Smith wrote [go to IV.7.149]:

Say to a shopkeeper, Buy me a good estate, and I shall always buy my clothes at your shop, even though I should pay somewhat dearer than what I can have them for at other shops; and you will not find him very forward to embrace your proposal.

In this case, Henry Ford is "the shopkeeper" and the Ford workers are "I." Smith goes on to point out, in one of the first public choice insights in written economics, that, of course, the shopkeepers are quite happy for others to be taxed to finance imperialism because their pro rate share of taxes is less than their benefits from having a protected market.

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CATEGORIES: Labor Market

COMMENTS (11 to date)
Daniel Kuehn writes:

If paradoxes of thrift could be solved by individuals there would be no paradox :)

I agree that this "efficiency wages" explanation is the right one. I'm sure Ford hoped and expected his workers would drive a Ford, but that clearly wasn't the point of the $5 day.

Steve Roth writes:

Obviously it doesn't make sense for any company to pay more to increase demand for its products; its workers constitute a tiny percentage of its customers. That anecdote has always struck me as questionable; Ford was no fool.

That does not mean, though, that it doesn't make sense for a whole economy.

I know you know the difference between the ant and the anthill; are you being intentionally obtuse? See Daniel Kuehn's first sentence above.

Broad-based demand is necessary to keep the whole economic log rolling and growing. That broad-based demand only comes from well-paid workers.

When wages as a share of national income drops too far, the log stops rolling, the wheels come off the bus.

OneEyedMan writes:

As a direct sales driver I agree this makes little sense. However, there is a quality benefit from having your employees use your product. They are the ones best equipped to find solutions to product flaws which they are much more likely to notice if they are using the product.

David R. Henderson writes:

@Steve Roth,
Not only am I not being "intentionally obtuse" but also I'm not being obtuse at all. I'm simply addressing the Ford issue.

Bill writes:

If paradoxes of thrift could be solved by individuals there would be no paradox :)

Let me fix that for you:

Since the paradox of thrift is solved by individuals, there is no paradox.

Rebecca Burlingame writes:

If I had a dollar for every book I've read which perpetuated that myth, I'd be eating a meal in a really nice restaurant tonight.

Eelco Hoogendoorn writes:

Broad-based demand is necessary to keep the whole economic log rolling and growing. That broad-based demand only comes from well-paid workers.

And well paid workers can only come from a productive economy. If you fiddle with just the numbers on their paychecks across the board, its the meaning of those numbers thats going to change, not the economy. Well, not in a good way, at any rate.

Let me dismantle the unstated but looming fallacy explicitly before it rears its ugly head once again: there is no market failure here, in the sense of there being a possibility of increasing total output of the economy by forcing up wages across the board.

Ford had a very productive company, which allowed him to pay higher wages. Ford wasnt the only one; it was a time of massive increases of productivity in all sectors of the economy. Absent these increases in productivity, the same changes in wages would have led to obvious disaster; not to the sudden invention of the combustion engine and the assembly line.

Steve Sailer writes:

Two things:

- Ford was worried about unionization, so raising wages was a win-win for workers and management. Workers got more pay and Ford got to continue driving up productivity without dealing with union featherbedding.

- Ford was setting an example for other capitalists. He was putting his money where his mouth was on the key question of whether the economy is a zero sum game fought out between capital and labor or whether technological advances, such as Ford's biggest breakthrough, the moving assembly line of 1914, could make it a positive sum game.

Ford couldn't sell many Model Ts to millionaires, but if the other millionaires came around to his way of thinking about the economy being a positive sum game and invested heavily in their own moving assembly lines, then he could sell millions more Model Ts to their workers.

Tracy W writes:

Steve Roth - I don't follow your point. Let's imagine a society built on slavery. In this case,
a small minority, the elite, lives in luxury, waited on hand-and-foot, another, somewhat larger minority, is the military, all the rest are slaves. The slaves do all the work, and only get enough subsistence to be able to raise the next generation of slaves. The slaves are larger than the total number of the military and the elite.

Occasionally a member of the elite or the military invents something useful, increasing labour productivity (the slaves are too poor to do so). Now why couldn't this extra productivity be just consumed by the elite and the military? Think of Ancient Egypt, with that massive diversion of resources into really big tombs. Or the palace of Versailles. (I know that there was more general wealth in those societies than in my model, all I'm thinking of here is big prestige products).

There are many disadvantages to such a society, but macroeconomically it strikes me that they're on comfortable ground.

Chris T writes:

A large share of societal wealth going to labor is a very recent phenomenon (and not necessarily an enduring one). For most of human history a small group of elites monopolized all wealth and capital.

Jack writes:

For 10+ yrs I've thought it was well-established that it was a so-called ''efficiency wage'', to minimize turnover, disgruntlement and sabotage, and to get better workers (not necessarily in ability, but in motivation and work ethic).

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