The Ford “buy their own product” myth

Posted by Marc Hodak on May 27, 2014 under Economics, Innumeracy | 3 Comments to Read

Whenever minimum wages are being debated, as they are once again, we can count on someone bringing up the old story about Ford’s $5-a-day gambit.  It goes something like this:

Ford Motor founder Henry Ford revolutionized the industrial landscape when he doubled his employees’ wages to $5 per day in 1914. The pay increase allowed his workers to buy the Model T cars they assembled every day on the factory line.

Enabling workers to “buy their own product” supposedly enables the creation of a mass market, helping producers as well as consumers.  But is that true?  And is that how Ford benefited from his wage hike?  Let’s look at the math.

In 1914, when Ford Motors instituted the $5-a-day wage, the company had about 14,000 workers making $2.25 a day, for a total wage cost of about $32 million.  Ford was selling about 250,000 cars a year at about $500 per car.  That’s about $125 million in total revenue.  So, let’s say that ALL of the increase in wages–$2.75 per day per employee for all 14,000 employees–went toward the purchase of Ford cars.  (Why that would have been impossible is a story for another time.)  That would be sales of about 20,000 more cars (yes, more than one car per worker), yielding Ford about $10 million dollars more in revenue.  So, the “buy-their-own-product” folks are asserting that Ford benefited by doubling his labor costs in order to increase his sales by less than 7 percent.  For one year.


The buy-their-own-product rationale is as historically mistaken as it is economically ridiculous.  Ford’s stated intent in dramatically raising wages was to reduce the huge turnover his new assembly line process had created, and the high costs of dealing with that turnover.  In other words, it was a bold solution to a novel production problem.

Furthermore, far from expecting any major increase in sales (i.e., from his own workers), Ford counted on having his profits significantly reduced that year as a result of the wage increase.  In fact, he was gleefully counting on it.  Why would Ford want his profits hurt that year?  Because he was in the middle of an outrageous gambit to squeeze out his fellow investors (and new car competitors) John and Horace Dodge, and a ding to the company’s profits that year would hurt them much more than it would Ford himself.  Ford, in fact, expected to realize the benefits of lower turnover in later years once his volume was greatly expanded (which is what eventually happened).

The idea that increasing your employees’ wages to enable them to buy your product is one of those ditzy notions that requires math blinders to believe.  Yet the “buy their own product” argument will continue to be made because belief is more powerful than math.

Ben Bernanke’s Speech

Posted by Marc Hodak on August 24, 2011 under Economics | Be the First to Comment

August 26, 2011.

Ben Bernanke goes up to the podium, and looks around at an expectant crowd, every ear bent in his direction, wondering what he will announce to kick start the economy. He sees the cameras trained on him, ready to carry around the world his brilliant musings, and his expert prescription for what to do next. The global markets await.

Ben clears his throat, looks around, and begins.

“Why are you all looking at me? What the hell do you expect me to do?”

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Improving financial literacy: Two approaches

Posted by Marc Hodak on July 7, 2010 under Economics, Patterns without intention | Be the First to Comment

The first approach is counting on government to do it from the center, as reported a few weeks back:

Don’t laugh, but Uncle Sam wants to teach you how to manage your money.

Tucked into the new financial-overhaul bill that Congress is working to finish is a new Office of Financial Literacy to help consumers learn about savings, debt and credit scores.

There is an obvious irony in a debt-laden, budget-challenged government offering financial education. But there is a deeper problem: While nearly everyone agrees that Americans of all ages and income levels could be more financially astute, no one has a good plan for making it happen.

(Raising my hand.)  Oh, I have a great idea!  Choose me!  Choose me!

Why not just ask all those government run schools to teach financial literacy alongside reading, writing, and math, and before inorganic chemistry and trigonometry.  If a school really wants to go whole hog, they have only to look at a great example of what works.

BP will suspend dividends! So what?

Posted by Marc Hodak on June 17, 2010 under Economics | 2 Comments to Read

A new symptom of financial illiteracy has been revealed by the obsession with BP’s dividends shown by politicians and the media, no doubt reflecting their readers’ sensibilities.  The narrative is that BP’s shareholders should share in the suffering their company has caused by having their dividends suspended.

This attitude reflects what can only be called a pre-war (WWII) view of financial economics, an alternate world where the breakthrough insights of John Burr Williams or the Nobel Prize winning theories of Miller or Modigliani or the resulting empirical transformation of modern finance theory never happened.

On an intuitive level, it doesn’t matter to the owner of a gas station if their cash is in the till at the office or their cookie jar at home. Why would it matter to the shareholders if their cash is still inside the company supporting their share price or mailed out to them in the form of a dividend check?

Of course, the answer is it doesn’t matter.

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Blind acceptance of government heroics

Posted by Marc Hodak on June 16, 2010 under Economics, Invisible trade-offs | Be the First to Comment

Alan Blinder, former Vice Chair of the Fed and Princeton economist, takes that school’s reputation down another notch in his panting defense of the the government’s performance during the recent financial crisis–particularly since President Obama took office.

The second landmark was the fiscal stimulus package that President Obama signed into law about four weeks into his presidency. Originally priced at $787 billion, it was later re-estimated by the Congressional Budget Office (CBO) to cost $862 billion. A huge waste of money, say the critics—even though most independent appraisals, including that of the CBO, credit the stimulus with saving or creating two million to three million new jobs…

Try to imagine any government spending a massive sum like $862 billion without creating or saving millions of jobs. More specifically, suppose peak-year spending from the stimulus bill was about $300 billion—which is roughly correct—and that our hapless government just sprinkled its purchases around at random. On average, each job in our economy accounts for about $100,000 worth of GDP. (We are a highly productive bunch!) So $300 billion worth of additional GDP should be the product of about three million more jobs. Do we really believe the stimulus produced only a small fraction of that—or none at all?

Try to imagine an economics department like Princeton giving an advanced degree for any candidate making such a silly argument.

Surely, Prof. Blinder can imagine a government like the Soviet Union spending a significant portion of their country’s GDP without producing any net jobs.  Or North Korea.  Even less communist countries like France and Greece who have spent public money like drunken sailors have not really created any net jobs.  In fact, the amount of jobs a country creates is just about inversely related to the amount of its GDP spent by its government.

Blinder is trying to trick the reader when says “jobs.”  He means gross jobs, not net jobs.  If I took $10,000 from ten people, and gave it to someone to spend a year digging ditches and filling them up again, that would look like a job “created” in Prof. Blinder’s world.   The fact that the $100,000 was not spent by its original owners to support jobs in dozens of grocery stores, clothing stores, car shops, etc. apparently doesn’t enter into his calculation.  An economist worthy of the name accounts for such secondary consequences of the policy they are defending.  (BTW – The fact that the money is borrowed instead of taxed doesn’t quite save this argument.)

The reality, of course, is that our hapless government did not sprinkle its largess at random, and it did not target its spending toward the areas of highest unemployment.  It funneled much of it to its preferred constituents/supporters in the most politically rewarding way, just as any government would do.

Why would an acclaimed economist like Alan Blinder resort to such sophistry?  Because the economics profession unfortunately does not distinguish between “economics” as a science, with the maddening circumspection that scientists must display in order to retain their reputations, and “economics” as advocacy, which appears to forgive the most unscientific assertions when made for a partisan cause.  Blinder wrote this garbage as an advocate, not as an economist.

A puritan village tries wage control

Posted by Marc Hodak on April 26, 2010 under Economics, History | Be the First to Comment

Reading about governance in the first villages of New England, I come across lessons that keep getting repeated, down to our time. In 1641 the English Civil War triggered an economic crisis across the ocean.  It threatened to disrupt relationships and supplies from the mother country upon which the colony depended, causing a number of the colonists to either sail back to England or move south where they could create a better subsistence for themselves.

The resulting turmoil caused a sharp drop in the price of land and commodities.  At the same time, with labor getting scarce, workmen were able to ask for much higher wages. Relatively larger landholders found themselves in an economic vise.  So, the town fathers, made up principally of these larger landholders, decided to pass wage regulations, limiting how much workmen could charge for their labor.  Here’s a sample of those rules:

Every cart, with four oxen, and a man, for a day’s work          5s.
All carpenters, bricklayers, thatchers                                           21d./day
All common laborers                                                                    18d./day
All sawyers, for sawing up boards                                                3s./4d. per 100
All sawyers for slit work                                                                  4s./8d. per 100

The grandees who argued in favor of this price list no doubt justified it by arguing (a) it was for the public good, (b) no worker should profit from economic turmoil, (c) no one was worth 10 s. per day, (d) it’s good to spread the pain, and (e) given that these limits would be imposed on relatively poor people living at the edge of civilization between an inhospitable wilderness and a gaping ocean, “where else could they go?

For you economics majors out there, what was the predictable outcome of these wage controls?

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Any excuse will do

Posted by Marc Hodak on April 21, 2010 under Collectivist instinct, Economics, History, Movie reviews, Politics, Reporting on pay, Stupid laws | Read the First Comment

The IMF is pushing for a bank tax:

[T]o pay for the costs of winding down troubled financial institutions, the IMF proposed what it called a Financial Stability Contribution”—a tax on balance sheets, including “possibly” off-balance sheet items, but excluding capital and insured liabilities. That tax would seek to raise between about 2% to 4% of GDP over time—roughly $1 trillion to $2 trillion if all G-20 countries adopted the tax.

On top of that, the IMF proposed that nations to adopt what it called a Financial Activities Tax, levied on the sum of profits and compensation of financial institutions. That would be paid to a nation’s treasury to help finance the broader costs of a financial crisis…

The IMF said that a nation didn’t need to put in place a specific resolution authority. Instead, the tax money could go to general revenues and used in case of financial crisis. But the IMF warned that the money would be spent by the time a problem arose.

OK, so let’s see how this would work.  Congress levies massive new taxes on every major bank.  Congress would then spend that money on…stuff.  A financial crisis hits, and certain TBTF banks get into trouble.  Congress bails them out, having to borrow gobs of money to do so because the tax revenues that were nominally for “Financial Stability” were in fact spent on…stuff.

So, how is this different from what happened last time?  Hard to see.  Does it do anything to reduce the systemic risks that regulators insist were at the root of the last crisis?  No.  Does it strengthen the banks to make them better able to weather such a crisis?  Not likely when so much money of their capital–enough to raise between 2% to 4% of GDP–is being sucked out of their coffers.  At least if the money were being held in a trust fund instead of dumped into general revenues, it would be there for frenzied politicians to disburse based on the rational workings of the government.  But, of course, the money will not be there.  It will have been spent not to support the financial system, but to support the reelection of incumbent politicians–the most short-term actors on the planet.

Oh.  Yeah.  THAT would be the difference.

So the lesson from all this appears to be:  When it comes to a justify raising taxes, any excuse will do.

“Violent criminals, long-term welfare recipients, the chronically sick, and politicians”

Posted by Marc Hodak on September 17, 2009 under Economics | Be the First to Comment

What do these people have in common?  According to Bryan Caplan:

Check whether the marginal human is, over his entire lifetime, self-supporting in present value terms.  A small fraction of people – such as violent criminals, long-term welfare recipients, the chronically sick, and politicians – probably don’t pass this test.  But even people who earn minimum wage probably do.

Unfortunately, “present value” is a term that is alien to most people, which makes them more likely to fall for the value-destroying programs of the politicians.

Caplan’s wit may have been inspired by Mel Brooks

The Broken Glass Fallacy

Posted by Marc Hodak on August 18, 2009 under Economics, Invisible trade-offs | Be the First to Comment

Driven to distraction

Driven to distraction

As anyone who has studied it knows, Cash for Clunkers program doesn’t accomplish any of its stated goals.  It does not materially reduce energy consumption because the difference between the mileages of the cars getting traded in versus the cars getting bought does not account for:

– The fact that the net difference in energy use and carbon dioxide emissions, etc. must more than outweigh the energy needed to build the new car, which includes mining the basic materials, transporting them to the factories, running the assembly plant, etc.

– The fact that one is likely to drive a high-mileage car with less concern for energy because it’s more energy efficient.

Once the environmental rationale gets swept away, then we are left with two items.  One of them is:  Even if it doesn’t help the environment, at least it creates jobs.

Wrong.  The $15,000 used to replace perfectly good “clunkers” with new cars is money that could have been used to buy other stuff–1,000 nice steaks, 2,000 peach cobblers, 5,000 romantic candles, etc.  The money you spent on a car is no longer available to the butcher, baker, and candlestick maker, which impoverishes them and the people selling to them about as much as it enriches the auto makers.  And because the cash-for-clunkers program represents a centrally planned, non-market allocation of resources, 11 or 12 B-B-CM jobs may easily have been destroyed for every 10 auto jobs created.  The difference, of course, is that most of the 10 jobs were union jobs in plants one can point to, whereas the 11 jobs destroyed were at dispersed bakeries, paraffin processors, etc. around the country–those that are not seen.

So, once the ‘environmental’ and ‘jobs creation’ rationale gets swept away, we are down to one:  It gives the sponsors of the bill the ability to funnel taxpayer money to preferred union constituents.

An economist summarizes the health care debate

Posted by Marc Hodak on July 3, 2009 under Economics, Invisible trade-offs | 2 Comments to Read

And does a great job of it.  He leads with a great punch:

- “The American people overwhelmingly favor reform.”

If you ask whether people would be happier if somebody else paid their medical bills, they generally say yes. But surveys on consumers’ satisfaction with their quality of care show overwhelming support for the continuation of the present arrangement. The best proof of this is the belated recognition by the proponents of health-care reform that they need to promise people that they can keep what they have now.

My own summary:  I’m amazed at the number of otherwise intelligent people who favor reform on the theory that we can’t individually afford the skyrocketing costs of health care, but that we can afford it collectively, and that by increasing the degree to which I’m paying for your health care and you’re paying for mine, we’ll bring those overall costs under control.