Ford's pay hike: It wasn't about profit
January will mark the 100th anniversary of Henry Ford's famous hike in his workers' daily pay from $2.34 to $5. It's an anniversary worth celebrating — but not for the reasons popularly given.
The popular explanation of Ford's pay increase is that Ford wanted to stimulate consumer demand for his Model T. By doubling his workers' pay, each Ford worker could buy a Model T and, in turn, the profits of Ford Motor Co. would rise.
This history of Ford's pay increase is bunk.
An obvious way to see why this popular explanation is mistaken is to apply it, say, to the small-jet manufacturer Gulfstream. Would that company increase its profits by raising the pay of its workers to a height that would enable each of them to afford the $14.5 million price tag of Gulfstream's lowest-priced jet (the G150)? Clearly not.
If business success were as easy to achieve as simply paying workers enough to allow them to buy the products they are hired to produce, few businesses would ever go bankrupt.
In fact, Ford doubled his workers' pay — and at the same time decreased his workers' standard work day from nine to eight hours — to reduce worker turnover.
Turnover was significant. In 1913, Ford Motor Co. hired 963 workers for every 100 jobs it filled during that year. In other words, the typical worker quit after only six weeks on the job. The costs of training all those new workers who would soon quit raised Ford's costs unnecessarily. By more than doubling employee pay — and by reducing the amount of time workers had to work to earn this handsome income — Ford reduced turnover and lowered even further the cost of producing the Model T.
While workers whose annual incomes doubled were, of course, better able to afford to buy new Fords, they were also better able to afford to buy nearly everything. No doubt some Ford workers did buy new Model Ts because of their doubled incomes. It's also undoubtedly true, however, that many Ford workers spent their higher incomes not on newly produced cars but, instead, on better housing, better home furnishings and better and more education for their children.
And even if each of Ford's 14,000 workers in 1914 did buy a new Model T that year, Ford's sales would have risen by only 5.7 percent. (The total number of Model T sales in 1914 was 260,720.) Doubling worker pay to generate a 5.7-percent increase in sales (of a product priced at about half of those workers' annual incomes) is a very poor business practice.
Still doubtful? Here's Forbes columnist Tim Worstall: “Say 240 working days in the year and 14,000 workers and we get a rise in the pay bill of $9 1⁄4 million over the year. A Model T cost between $550 and $450 (depends on which year we're talking about). 14,000 cars sold at that price gives us $7 3⁄4 million to $6 1⁄4 million in income to the company.
“It should be obvious that paying the workforce an extra $9 million so that they can then buy $7 million's worth of company production just isn't a way to increase your profits. It's a great way to increase your losses though.”
Ford's better idea was to use a pay hike to reduce worker turnover.
Donald J. Boudreaux is a professor of economics and Getchell Chair at George Mason University in Fairfax, Va. His column appears twice monthly.
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