Ford's Five-Dollar Day

    "Ford grasped that Big Business, with its economies of scale, could lead to even bigger business provided it shared its profits with its workforce by paying handsome wages.  In 1914, when industrial workers were averaging about $11 a week, he abruptly decided to pay his men $5 for an eight-hour day, so that they could all buy his Model Ts.  The idea was obvious but new, and valid."  (Paul Johnson, A History of the American People, pp. 606-7)

    Johnson is saying or implying four things:

  1. That Ford paid above market wages.
  2. That his PURPOSE was to increase his profits.
  3. That the policy WORKED:  it did increase Ford's profits.
  4. That the MECHANISM by which the policy worked was that it gave his workers more money with which to buy his products.
    But I say that the idea is not valid:  at least one of these four claims is wrong.

    In particular, consider (4)    It is not credible that Ford raised his profits by giving his workers more money with which to buy his product.  Even in the unlikely case that the workers spend the ENTIRE wage increase on Ford cars, so that Ford gets the entire wage increase back in higher revenues, he still loses, because he has to pay the cost of making the extra cars the workers buy.

    To see this, suppose Ford is considering giving Tom a $700 gift, to spend in any way Tom chooses.  Let us give the policy the benefit of the doubt and suppose, most improbably, that Tom decides to spend the ENTIRE $700 on Ford cars.  Ford STILL loses money.  It's true that he gets his $700 back, but he still incurs the cost of MAKING the extra cars Tom buys.
    For example, if it costs Ford $500 to make the extra cars Tom bought, the change in Ford's profit is:

-$700       (the gift to Tom)
+$700        (Tom's spending on Ford cars)
-$500        (the cost to Ford of making the cars)
----
-$500    so Ford loses $500
    Now suppose that Tom is a Ford employee who currently makes $600/yr.  Then Ford raises Tom's wage to $1300/yr.  In fact this is the same example as before:  the wage increase is simply a $700 gift, so the above analysis applies:  even in the unlikely case that Tom spends the entire wage increase on Ford cars, the wage increase still lowers Ford's profits.  Why?  Because, even if Ford gets the entire wage increase back in increased sales, he still has to pay the cost of producing the cars which Tom buys.

    To see how silly (4) is, suppose that, instead of increasing Tom's wage by $700, Ford gives Tom a $700 Ford car.  This is actually a BETTER policy than giving $700 cash, since it only costs Ford $500, but it would be futile to hope it would raise Ford's profits.

    Although, empirically, if Ford gave Tom a gift, Tom would not spend the entire gift on Ford cars, it is not LOGICALLY impossible that Tom might do so.  Indeed, it is not logically impossible that the gift might cause Tom to increase his spending on Ford cars by MORE than the gift.  Indeed (even if Tom is guided solely by self-interest and not by gratitude to Ford), it is not logically impossible that Tom might increase his spending on Ford cars by so much more than the gift that the gift would in fact raise Ford's profit.

    If you know some demand theory, you can calculate the condition for this unlikely situation yourself.  Try it before you check this link.

    If (4) is wrong, why did Ford raise his wages?  Perhaps

  1. Ford was not paying above market wages.  He had to pay high wages (a) to get workers with the skills he wanted, or (b) to make workers willing to work as hard as he wanted, or in an assembly-line setting, or (c) to get workers to put up with his outside-the-factory regulation of their lives.
  2. If (c) is right, then Ford wasn't trying to max his profits, but to indulge his totalitarian instincts.  Or he might have raised wages as a stunt, to indulge his instincts for adultation.  Or his motives might have been charitable.
  3. There is evidence that Ford really believed that raising wages would raise his profits, not necessarily by increasing the workers' own consumption of Ford cars, but indirectly, by promoting general prosperity.  "Our own sales depend in a measure upon the wages we pay." (Jonathan Hughes, The Vital Few, 1986, p. 304)  If so, he was trying to increase his profits, but in a mistaken manner.
  4. Perhaps Ford WAS paying above market wages:  efficiency wages.  Ford's assembly line offered numerous opportunities for shirking.  By raising the value of their jobs, Ford reduced workers' shirking.  "It was said that Ford's workers were simply terrified for their jobs."  (Hughes, p. 303)
    My illinformed guess is that while there was an efficiency wage aspect, the main motive was a mix of charitable and attention-craving impulses.
 

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