Henry Ford raised wages so his workers could buy his cars.

Source: AFP/Getty Images

Let the Pay Hikes Begin

Justin Fox is a Bloomberg View columnist. He was the editorial director of Harvard Business Review and wrote for Time, Fortune and American Banker. He is the author of “The Myth of the Rational Market.”
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First he asked executives at his company to read Thomas Piketty’s "Capital in the 21st Century." Then Aetna Chief Executive Officer Mark T. Bertolini announced Monday that the company will raise the wages of its lowest-paid workers to at least $16 an hour and cut their health-care bills.

One way to look at this is as a reaction to the improving economy -- and a sign that serious upward wage pressure may finally start showing up in employment statistics this year. That’s part of it, Bertolini told The Wall Street Journal, as is the fact that Aetna’s business is becoming more dependent on selling coverage to individuals, meaning customer service has to improve. But there’s also that Piketty thing:

It’s not just about paying people, it’s about the whole social compact. Why can’t private industry step forward and make the innovative decisions on how to do this?

Yeah, why can’t it? The standard answer for quite a while now has been that in a competitive global economy, companies can’t afford to pay workers more than they’re worth.

Political scientist Jonathan Schlefer lays the blame (or gives the credit, if you prefer) for this sort of thinking on economist John Bates Clark, who wrote in 1899 that:

where natural laws have their way, the share of income that attests to any productive function is gauged by the actual product of it. In other words, free competition tends to give to labor what labor creates, to capitalists what capital creates, and to entrepreneurs what the coordinating function creates.

Earlier economists such as Adam Smith and David Ricardo didn’t always see it that way. They depicted the setting of wages as a social decision as much as an economic one. Ricardo (this is from Schlefer again) believed that the income distribution depended on the “habits and customs of the people.”

Most likely it’s a mix. Productivity plays an undeniable role, but so do those habits and customs, which can change. The minimum wage research of the past few years may be wildly inconclusive, but it does seem to indicate that there’s at least some room on the margin for using non-market means to push incomes upward.

Then there’s the matter of whether higher wages themselves do economic good. Henry Ford’s 1914 announcement that he was going to double the wages of his assembly line workers is an oft-cited case study. The story goes that he did this so his employees could afford to buy the cars they were making.

David Leonhardt looked into this a few years ago and found that this was an after-the-fact explanation, but it was one that resonated for more than half a century. “More production could lead to better wages,” is how Leonhardt described the resulting popular philosophy, “which in turn would lead to more spending by the public, yet more production and eventually even higher wages.”

Mainstream economists were never entirely comfortable with this reasoning, but some came up with another justification for what Ford did: the “efficiency wage.” As Daniel Raff and Larry Summers described the thinking in 1986:

These theories have in common that over some range a firm can increase its profits by raising the wage it pays its workers to some level above the market-clearing one. A variety of mechanisms, turning on the role wage increases might play in eliciting effort, reducing turnover, attracting better workers, and in improving morale, have been suggested to explain why profits might be an increasing function of wages.

From the looks of things on Google Scholar, interest in efficiency wages seems to have petered out after about 1990. (Well, except maybe at Cornell, where Aetna’s Bertolini got his MBA. And now Justin Wolfers and Jan Zilinsky are trying to resurrect it.) Which sort of fits. By the mid-1990s the idea that companies had to keep wages low to be competitive globally, and that this thing called “the market” simply could not be defied, was pretty widespread. It was in those days, I remember, that people outside Wall Street first began noting -- first with dismay, then with resignation -- that big corporate layoff announcements were usually followed by stock price increases.

That’s apparently still a thing. And when Leonhardt assessed the legacy of Ford’s wage hike in 2006, he concluded that the link between economic growth and high wages for the average worker seemed to have been severed. The U.S. economy is a lot bigger now than it was in 1989; the median household income, adjusted for inflation, hasn't budged (and yes, it's more complicated than that, but that's a topic for another column). 

Still, the financial crisis and subsequent Great Recession have changed the tone of the discussion somewhat. Minimum-wage hikes are in fashion. Business Insider’s Henry Blodget has been waging a years-long campaign to persuade the business world that lack of wage hikes has been holding the economy back, with some success. And now here’s this Bertolini guy saying his company needs to start paying its people more.

As CEOs of major corporations go, Bertolini is a little different. He does yoga and believes in alternative medicine. He was the first straight board member of the National Gay and Lesbian Chamber of Commerce. He says things like, “I have enough narcotics in my cabinet at home to put families through college.” (That last is from a remarkable interview at the 2013 Techonomy conference.) Just because he’s going in this direction doesn’t mean his CEO peers will follow. Still, it is out of steps like these that big societal shifts are made.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

To contact the author of this story:
Justin Fox at justinfox@bloomberg.net

To contact the editor responsible for this story:
Paula Dwyer at pdwyer11@bloomberg.net