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Paid Enough to Buy the Product

Mises Daily: Tuesday, January 11, 2005 by

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In the past several years, a virtual industry has been created in bashing Wal-Mart. From leftist church groups to the AFL-CIO to the Chronicles, Wal-Mart has been the favorite whipping boy of people on all sides of the political spectrum. Thus, it was no surprise when I recently received an emailed article from the quasi-Marxist Sojourners magazine not only attacking Wal-Mart for the usual set of "sins" that the critics claim, but also a new transgression: Wal-Mart's business practices, on net, make our economy worse off and leave us poorer.

In its latest example of Wal-Mart bashing (Sojourners gives its readers the links to anti-Wal-Mart websites and pathologically publishes attacks on the retail giant), David Batstone and David Chandler compare the company unfavorably with another giant, Ford Motor Company, or at least the Ford of the early 20th Century. Before going into detail about the contrasts that Batstone and Chandler make, however, let me say that their choice of comparison is odd, considering that Ford was the premier target of leftists of his day and socialists considered him to be the worst "reactionary" on the industrial scene in that era.

Write Batstone and Chandler:

Nearly a century ago, Henry Ford planned for his employees to be his best customers. Challenging the conventional wisdom that the best way to maximize profits was to tailor your product to the wealthiest segment of society, Ford decided to market his black Model T as "America's Everyman car."

For Ford, mass production went hand-in-hand with mass consumption. He established a simple benchmark for worker compensation: His workers should be able to buy the product they were making. Ford promised a $5-a-day minimum wage for all his workers—twice the prevailing automobile industry average.

Doing so, Ford created a virtuous circle. Workers flocked to his factory to apply for positions. If they managed to secure a coveted job, then in time they too would be able to afford one of his cars. The company flourished on these twin pillars—a desirable product and a highly motivated employee base. By the time production of the Model T ceased in 1927, Ford had sold more than 15 million cars—half the world's output.

If the reader believes that something is amiss in their claim, that is a good observation. Batstone and Chandler have managed to repeat an old economic and historical falsehood: the belief that Ford's actions somehow "created" the American middle class. To put it another way, if one is to accept the Batstone and Chandler theme, then one would have to say that the way for businesses to increase sales and profitability would be for them to double their labor costs. Surely, something does not compute in that statement.

The authors' claims to the contrary, Ford was not trying to make sure his employees could purchase his automobiles, and if one gives this whole concept even a moment's thought, it is not difficult to see that the authors have laid out an impossible scenario. (Granted, leftists are not known for sound economic logic, otherwise, they would not be leftists.)  If one wishes to see a systematic dismantling of this silly notion, Henry Hazlitt in his classic Economics in One Lesson does so in his chapter, "Enough to Buy Back the Product."

Yet, there has to be a logical reason why Ford doubled his employees' wages from $2.50 to $5 daily in 1914, yet economic logic demands that it be something other than a desire for him to increase his production costs. Burton Folsom, Jr., answers that question in his January 1998 article in The Freeman:

One argument against the assembly line was that the work was monotonous. Ford almost conceded this point when he said, "There is not much personal contact—the men do their work and go home." Ford did keep his factories well lighted and ventilated, and he worked hard to prevent accidents on the job. But the work was not challenging. Partly as a result, he (and many other industrial employers) had high rates of turnover and absenteeism. Ford found himself spending $100 to train each new worker, though many stayed only for a month or two and then quit.

Ford's reaction to this problem was dramatic: in 1914 he doubled his minimum wage to five dollars a day and cut daily working hours from nine to eight. The experiment caught the industrial world by surprise. His competitors were startled; his workers were energized. Ford himself was ecstatic. Some of the most talented workers in Detroit lined up by the thousands to apply for jobs with Ford. He couldn't hire as many as he would have liked because turnover and absenteeism almost disappeared overnight. No one wanted to lose his job. As a result, production surged and profits skyrocketed. Ford happily paid the higher wages and also cut the price of the Model T by over 10 percent in 1914, 1915, and again in 1916. With each cut, more and more of his workers could afford to buy the cars they were making.

Ford was delighted to violate "the custom of paying a man the smallest amount he would take." And yet "[t]here was . . . no charity in any way involved. . . . The payment of five dollars a day for an eight-hour day was one of the finest cost-cutting moves we ever made." Ford was so pleased that in 1922, when Model T sales began to top a million a year, he raised his minimum wage to six dollars a day. Meanwhile, he cut the price to about $300. With all of their manufactured steel, vulcanized rubber, and processed plate glass, Model Ts were selling at about 25 cents a pound—perhaps the best bargain in the industrialized world.

In economic parlance, Ford decided to pay an "efficiency wage," that is, a wage that substantially raises the employee's opportunity cost of quitting or losing a job. Payment of such a wage makes sense only when it results in substantial cost-cutting elsewhere, and in Ford's situation, that was exactly the case. The company's costs associated with turnover and training had become overwhelming, so by increasing pay and cutting working hours, Ford was able to realize substantial savings that were greater than the added amount of daily wages he was paying.

To put it another way, Ford was not engaging in an act of humanitarian charity, and, as Folsom has pointed out, that view came from Ford himself. The idea that his decision to raise wages somehow "helped lay the foundation for a rising middle class in America," as Batstone and Chandler claim is ludicrous, but entirely understandable when one fails to realize that living standards within a society rise only when productivity increases.

Not having been satisfied with mangling the historical record, Batstone and Chandler now turn on Wal-Mart:

While Ford's business model helped lay the foundation for a rising middle class in America, the Wal-Mart model reinforces downward mobility. Wal-Mart today is the largest commercial employer of labor in the United States. In 2002, 82 percent of American households bought something at Wal-Mart. Americans must love to shop at Wal-Mart; on the other hand, maybe they have no choice. A sizeable percentage of Wal-Mart's sales come from low-income households.

The authors make an interesting (but internally inconsistent) claim that (1) people choose to shop at Wal-Mart, (2) they do so because they have no other choice, being that many low-income people shop there. Actually, people do have another choice, that is not to go to Wal-Mart or shop elsewhere. The implication here is that Wal-Mart is evil because poor people can afford to buy its products.

Of course, Sojourners since its original inception about 30 years ago has railed against what it calls "consumerism."  Now, the term "ism" would seem to represent an ideology or way of thinking, but it is difficult to claim that choosing to purchase relatively inexpensive goods is an ideology. What the editors of Sojourners, along with their fellow ideological travelers, really dislike is the fact that low-income earners are able to purchase low-price goods without the aid of the state, or at least that Wal-Mart is a private, not state-run outfit.

(As a semi-regular reader of Sojourners since the magazine was begun, I can assure readers of this article that scarcely an issue passes without the editors or writers advocating more power to the state, along with the increase of government regulation and the demise of private property. Moreover, the editors and writers always invoke religious arguments to buttress their anti-capitalist ideology. Whether or not Christianity is intrinsically against free markets and private property is not the focus of this article, although I would claim that it is not.)

However, Batstone and Chandler don't stop at attacking Wal-Mart for selling inexpensive goods to poor people. They go farther and claim that Wal-Mart's cost cutting is the source of economic distress:

The effort to minimize production costs is a legitimate business strategy; no argument there. But does Wal-Mart realize that the employees whose wages they squeeze are often the customers upon whom they rely to fuel their business?

While Ford created demand and wealth with a new and innovative product, Wal-Mart displaces existing demand—siphoning consumption from elsewhere by under-cutting prices. Wal-Mart sets the pricing agenda in whichever market it enters. Suppliers and competitors are squeezed—forced either to push jobs overseas themselves, or forced out of business altogether.

The argument is not unlike Lenin's theory of imperialism. In his analysis of why the developed nations engaged in imperialistic adventures, Lenin claimed that because capital investments in the developed nations promised no more profitability, it was then necessary for capitalists to invest elsewhere. (Like Batstone and Chandler, Lenin believed that increased productivity was the source of low wages and unemployment.)

In the Wal-Mart case, the authors claim that Wal-Mart is able to produce low-priced goods primarily by "squeezing" workers through low wages. Thus, instead of Ford's "virtuous circle" that allegedly was created by raising wages, Wal-Mart creates a "vicious" circle in which low wages paid to workers create the need to cut prices, which is done by cutting wages and so on. In case one does not recognize the logic, it is classical Marxism. (I am not claiming that the writers are hardcore Marxists, but rather that—wittingly or unwittingly—they have borrowed Marx's argument, but since Marx was incorrect, we also can assume that Batstone and Chandler also are wrong.)

Here is the problem with their economic argument: it makes no sense. It is based upon the assumption that Wal-Mart faces no competition from other employers and can cut pay at will with no resultant loss of employees. Furthermore, if they are correct about Ford, it would seem self-contradictory that other employers would not have "discovered" the passageway to the "virtuous circle," given that such actions would make their businesses more profitable. That other employers do not follow what the authors claim was the Ford path can be due only to evil motives on behalf of employers or gross ignorance of history.

Not satisfied with basing their anti-Wal-Mart screed on discredited Marxist logic, the authors then turn their verbal blasts at capitalism in general:

The single-minded pursuit of economic growth can exact a heavy toll on a community. Our economic goal of creating wealth should coincide with our ideals of human and societal development. In today's business environment dominated by Wal-Mart, Henry Ford's ideas would be as revolutionary as they were when they were first applied.

Indeed, Ford's ideas were revolutionary, but not in the way that Batstone and Chandler might think. Ford was able to apply new production techniques and relentless cost-cutting approaches to manufacturing. The result was twofold: his workers were able to be paid more than workers in other industries, and individuals across the economy were able to purchase high-quality automobiles.

Ford's triumph was due to his following the standard approach of cutting costs and boosting production. Ironically, Ford's approach was no different than what Wal-Mart has been doing. Yes, as the authors claim, Wal-Mart's success does result in less efficient producers going out of business. However, think of all the carriage makers and buggy whip manufacturers that disappeared in the cloud of dust left by the Model T.

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William Anderson, an adjunct scholar of the Mises Institute, teaches economics at Frostburg State University. Send him MAIL. See his Mises.org Articles Archive. Comment on the blog.