Henry Ford's $5 Day

Perhaps you, like me, have heard of Henry Ford's $5 day: how Ford more than doubled the pay of his employees--making them, by far, the highest-paid workers in America back in the 1910's.

Perhaps, too, you have heard--as I have--that he did this because he was so far-seeing and so wise that he understood that, by paying his workers such high wages, they would be in a position to purchase his cars: he was, according to this story, almost some kind of utopian.

Today I read an article that explains Ford's thinking in a way that makes a lot more sense to me.

In essence, his wage increase may have helped his workers to afford the purchase of Ford motor cars. But that benefit was secondary. The primary purpose of the wage increases was for more mundane and businesslike.

In 1913, Ford had an employee turnover rate of 380%, which required hiring 52,000 workers annually to maintain a work force of 13,600. In addition to the cost of replacing workers, productivity suffered from a 10% absentee rate, and the workers who showed up were inexperienced and commonly shirked as much as they worked.

Higher wages remedied these problems. Anxious prospects lined up in hopes of being hired by Ford, who employed only those whose personal habits indicated they would be dependable workers as determined through investigations, including home visits, by his personnel department. Ford paid for dependability, and he got it.

In 1915, Ford's turnover rate fell to 16% as productivity soared. He reduced the Model T's price by 10% each year from 1914 to 1916, and his annual profit increased to $60 million from $30 million. Ford was quoted as saying that more than doubling wages "was one of the finest cost-cutting moves we ever made."

Read that last sentence again: Doubling wages was one of the finest cost-cutting moves Ford ever made!

Now, that doesn't mean the same kind of move would yield similar results today. But at least at that time and in those circumstances, the high wages yielded dramatic cost-cutting benefits because they generated dramatic improvements in efficiency and consistency within Ford's labor force.

Having made this key legend-breaking observation, the author of the article I have quoted goes on to make some trenchant observations about America's economy today . . . and about government economic policies. They author says that the lessons we have been taught about Ford's pay raise--that Ford was trying to increase workers' income so that they would be in a position to purchase more--is exactly backwards. But that backwards lesson is what our federal government has used to justify its economic stimulus policy decisions from the 1930s till today.

The prevailing view in the 1930s was that increasing wages . . . would increase purchasing power . . . , and therefore demand.

This view was the justification for polices that raised hourly wages, . . . strengthen[ed] labor unions, shorten[ed] workweeks, . . . restrict[ed] pay cuts, and raised prices by destroying agricultural products and reducing competition.

Unfortunately, the . . . political approach to increasing purchasing power was to reduce production, while Ford's approach was to increase production. The political approach failed because any policy that reduces the production of goods and services that people want to purchase necessarily reduces purchasing power.

This is just as true today as it was in the 1930s. Yet, almost without exception, the Obama administration's hope for economic recovery relies on the demand-side fantasy that purchasing power can be increased with policies that reduce supply by increasing production cost or destroying what has already been produced.

The "Cash for Clunkers" program required the destruction of perfectly good cars. Companies bankrupted by high production costs were bailed out with taxes on the profits of companies that kept production costs under control.

The recently passed health care legislation is poised to increase the cost of doing business in ways that are complex and uncertain. Firms are threatened with proposed legislation that would increase the cost and reduce the productivity of workers by eliminating secret ballots in union elections.

All these policies, and more, are being justified by the Obama administration, at least in part, as a way of increasing purchasing power and generating jobs.

But they are retarding the market adjustments needed to lower production costs and expand the supply of goods . . . [on] which increases in real purchasing power and real wages depend.