Don't worry, Ford made plenty of money.

Employees Are Not Your Customers

Megan McArdle is a Bloomberg View columnist. She wrote for the Daily Beast, Newsweek, the Atlantic and the Economist and founded the blog Asymmetrical Information. She is the author of "“The Up Side of Down: Why Failing Well Is the Key to Success.”
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The other day, I noted in passing that it is arithmetically impossible, except in some bizarre situation with little bearing on the real world, to make money by paying your employees more and thus enabling them to afford your products.

Someone asked me to show my work. So let’s run a simple model based on Henry Ford’s legendary $5-a-day wage, introduced in 1914, which more than doubled the $2.25 workers were being paid.

That’s about $700 a year, almost enough to buy a Ford car (the Model T debuted at $825). Now let’s assume, unrealistically, that the workers devoted their extra wages to buying nothing but Model Ts; as soon as they bought the first one, they started saving for the next.

Is Ford making money on this transaction? No. At best, it could break even: It pays $700 a year in wages, gets $700 back in the form of car sales. But that assumes that it doesn’t cost anything except labor to make the cars. Unfortunately, automobiles are not conjured out of the ether by sheer force of will; they require things such as steel, rubber and copper wire. Those things have to be purchased. Once you factor in the cost of inputs, Ford is losing money on every unit.

But can the company make it up in volume, as the old economist’s joke goes? Perhaps by adding the workers to its customer base, Ford can get greater production volume and generate economies of scale. But Ford sold 300,000 units in 1914; its 14,000 employees are unlikely to have provided the extra juice it needed to drive mass efficiencies.

Does this mean Ford couldn’t make money by paying higher wages?

No, of course not. It might be getting efficiency-wage effects, which we discussed earlier in the week. It might be making its workers able to afford better food and health care, making them more productive. It might be getting a better class of worker.

But the particular mechanism that is often suggested -- for Ford, Wal-Mart and other employers -- is nonsense. You cannot make money by enabling your workers to spend more money at your store. You make money by selling stuff to the people who don’t work for you.

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To contact the author on this story:
Megan McArdle at mmcardle3@bloomberg.net

To contact the editor on this story:
Brooke Sample at bsample1@bloomberg.net