HENRY BLODGET AUG. 29, 2012, 11:06 AM 45,612 83
In 1914, a business executive named Henry Ford did a startling thing:
He announced that he was going to more than double the wages he was paying his employees, from $2.34 to $5 a day–the equivalent of $120 a day in today’s money.
The country was as shocked by this then as it would be today.
A powerful company voluntarily sharing some of its profits with its rank-and-file workers and paying them more than it absolutely had to?
Had Henry Ford gone mad?
Didn’t he understand that the only goal of a business was to make money?
Didn’t he realize that, as a successful business executive, he was entitled to make as much money as he could possibly make–the financial health of his employees being nobody’s business but their own?
Didn’t he understand that smart executives pay their employees no more than “market rates” because the executive’s job is to “create shareholder value,” everyone in our economy gets what they deserve, and the financial well-being of employees is not something that business owners or bosses or shareholders should be concerned with?
Yes, Henry Ford understood all that.
The story you hear frequently about why Henry Ford made this decision was that he wanted to allow his workers to be able to afford to buy his cars. The wage increase certainly made the cars (and many other products) more affordable for Ford employees, but the historical consensus is that Ford actually made this decision for a different reason: To reduce employee turnover–and, in so doing, reduce recruiting and replacement cost.
Regardless, it worked.
Thousands of people immediately lined up to get jobs at Ford. Employee turnover plummeted, and recruiting and training costs dropped. The new wages allowed Ford employees to live middle-class lives, instead of being poor. And it presumably made Ford, Ford’s senior executives, and Ford’s shareholders even more proud of what they had created.
In short, instead of viewing “shareholders” and “customers” as the only two corporate constituencies that matter, Ford introduced the idea that great companies should also serve a third constituency:
And because one company’s employees are another company’s customers, Ford’s decision helped spread the country’s wealth to more citizens and expand the purchasing power of the country as a whole. And, in so doing, it helped the overall economy.
Specifically, Ford’s unprecedented move also helped usher in an age in which the middle class became the driving force in the American economy, turbo-charging the nation’s economic growth right up through the early 1980s, when relative middle class wages began to decline.
Henry Ford’s story is highly relevant today.
Because we are facing a very similar economic problem as the country did in the early 20th century. A glut of labor was allowing companies to pay a pittance for a day’s work, leaving most of their dedicated employees destitute. Business owners and executives (the equivalent of today’s 1%) did fine, but most rank-and-file workers did not. And this lack of spending power in the middle class crimped overall economic growth.
If we want to fix today’s ailing U.S. economy, we need many of our large corporations to do what Henry Ford voluntarily did:
Share more of their vast wealth with their rank-and-file employees.
If the companies don’t eventually see the benefit of doing this and do it voluntarily, the government (an extension of the people) will likely the mandate that they do it–either through taxation or by radically increasing the national minimum wage.
And given that government solutions are often terrible solutions, it would be best for everyone if we persuaded corporations to do this voluntarily. So what follows is an initial effort to do that.
Here’s The Real Problem With The Economy
There’s a lot of sturm und drang these days about who wrecked the economy. And there is a lot of yelling about how to fix it.
But the economy is complicated, so it’s easy to get fooled by someone who is yelling persuasively, especially if they play for your favorite political team.
Lots of things are wrong with the economy, but the main problem can be summed up with two simple facts:
- Corporate profits as a percent of the economy are at an all-time high
- Wages as a percent of the economy are at an all-time low
The following charts clearly illustrate that problem.
WHAT’S WRONG WITH THE ECONOMY?
1. The health of any business or economy depends on the health of its customers, and most American customers (consumers) are strapped or broke. Consumers account for about 70% of the spending in our economy, and the other 30% is tied to consumer spending (when consumers are broke, businesses don’t spend–because there’s no one to sell to.)
This sad state of affairs can be seen in the following chart, which shows that the vast majority of the income in the country goes to the top 50%. The bottom 50%, meanwhile, earn less than $30,000 per year.
2. Most American consumers are strapped or broke because most of the income gains in the past 30 years have gone to the top 10% (and especially the top 1%). The chart below shows the growth of incomes over the past ~90 years. The pink section is the 1%.
3. This increasing inequality has many causes, including globalization (cheaper labor overseas), a decline in the minimum wage, the decline of private-sector unions, changes in the tax code (tax cuts for the highest earners), and other factors. But the bottom line is: Average hourly earnings in America (adjusted for inflation) have not increased in ~50 years. (Total compensation, which includes health insurance, vacation time, and other benefits has increased, but workers can’t spend those things).
4. At the same time, earnings for the highest-income Americans have gone through the roof. For example, check out how compensation for senior executives has grown relative to compensation for “average production workers” and the minimum wage (which has actually declined after adjusting for inflation). And this is just since 1990.
5. Importantly, the problem here is NOT the weak health or profitability of American companies (which was a problem in the early 1980s). American companies are earning more as a percent of the economy than they ever have.
6. One of the reasons American companies are earning so much money is that they’re paying very little to their rank-and-file employees. This is also why average earnings have been stagnant for 50 years and most American consumers are broke. Wages as a percent of the economy are at an all-time low.
7. Meanwhile, a lot of Americans don’t even have jobs, so they’re not earning anything. The employment-to-population ratio is lower that at any time in the past 30 years.
Put all this together, and the problem in the economy becomes clear:
- Too few jobs
- Too little pay
HOW TO FIX THE ECONOMY? Think Like Henry Ford
Some people argue that the way to fix the economy is to give tax cuts to the highest-earning Americans–the “job creators”–so that they can invest in new companies and create jobs.
Well, we’d all like to pay fewer taxes, but unfortunately, the “tax cuts for the rich” approach almost certainly won’t work. Here are a few reasons why:
- The richest Americans and companies already have plenty of cash
- The reason these rich Americans and companies aren’t investing and “creating jobs” is that most American consumers (customers) are broke
- Rich Americans actually don’t “create jobs”–the whole economy creates jobs
- We’ve been trying the “tax cuts for the rich” approach for three decades, and it is making the inequality problem worse, not better
Now, some other people are arguing that the way to fix the economy is to increase taxes on the rich and companies and “redistribute” this wealth to American consumers.
We will probably need to raise taxes on everyone a bit to reduce the budget deficit (even if we reduce spending–the gap is that big), but this “wealth redistribution” approach also almost certainly won’t work. Here are a few reasons why:
- The key to creating a sustainable economic recovery is to get the private-sector cranking, not the public sector
- Having the government collect taxes and write checks to more than half the country to make things “fairer” will understandably ruffle the feathers of those who are paying those taxes
- Class warfare won’t help anyone
- This is America: We solve our own problems in this country–we don’t wait for someone else to come along and give us a handout.
So, then, if the answer isn’t 1) cutting taxes for rich Americans and companies, or 2) raising taxes on the rich and giving the money to the poor, what’s the answer?
Let’s go back to the problem.
Here’s the problem in one simple chart:
Corporate profits (blue) are at an all-time high, and American wages (red) are at an all-time low.
This has created a situation in which American corporations and their owners are rich and American consumers are broke.
So, how do we fix the problem?
We persuade American corporations (and their owners) to hire more employees and pay them more, thus giving these employees (American consumers) more spending money. In other words, we take some of those surplus corporate profits and invest them in Americans.
Put differently, we instill a new value system in our companies, one in which employees–American workers–are treated as a constituency that is as important as the two other corporate constituencies that everyone already agrees are important–shareholders and customers.
Jerry Maguire might have put it this way:
“Lower profits, higher wages.”
Persuading corporations to hire more Americans and pay them more will fix the American economy. It will not require the government to raise taxes or grow even bigger. It will not require us to “soak the rich.” It will not even be a government solution.
All it will do is restore balance to a system that has become very imbalanced in the past three decades.
Of course, whenever you suggest that the answer to our economic problems is to persuade corporations to pay their employees more, most people howl with laughter. Persuade corporations to pay people more? What, are you insane? They’ll never pay people more!!! They’re in this for profit!
Well, when people laugh at you for suggesting that corporations should pay people more, you can just point out the following:
Eventually, this will help increase corporate profits.
Because paying Americans more will not just lead to a reduction in near-term profits. It will also lead to faster revenue growth. Because American consumers–the customers of all our companies–will have more spending money.
In other words, corporations don’t have to suddenly become good citizens when they decide to pay Americans more. They can keep on being relentlessly competitive profit-seekers. They can pay employees more with the knowledge that this will eventually lead to faster revenue growth, which will eventually lead to higher profits. So they can do it in their own self-interest!
Make no mistake: The kind of inequality that we have developed in the past three decades is very destabilizing. When the vast majority of people feel as though they’re getting shafted at the hands of a privileged few, they tend to rise up and rebel. This can lead to the election of radical leaders, or, worse, violent revolutions.
The inequality we have developed, in other words, will solve itself one way or another. The richest Americans and companies cannot keep getting richer while the rest of the country gets poorer without the entire system eventually collapsing.
So, it would be nice if we made the necessary changes voluntarily, before everything goes to hell.
And, besides, viewing employees as a very important corporate constituency isn’t just good for the economy–it’s also good for the soul. We’re all in this together. And no one can do it alone.
So, how about it, corporate America?
How about taking a few percentage points of your record profits and use it to hire more employees and pay your existing employees more?
Remember: Henry Ford paid his employees more than he had to.
And it worked out for him.
And “the Henry Ford way” is the way we’re going to fix our economy.