The Paradox Of Cheap Labor

Living standards rise when wages increase faster than inflation. When companies are able to reduce the price of goods and services they offer, that helps lower inflation and – all things being equal – increases living standards. But not all cost cutting techniques are equal. Lowering costs through efficiency improvements is very different than lowering them through pay cuts.

For example, consider the Ford Model T. Through improvements in processes and technology, Henry Ford was able to reduce the price of the Model T from $825 in 1908 to just $440 in 1915. Eventually, it’s price dropped to as low as $260.

On October 7, 1913, a rudimentary final assembly line was rigged at the new Highland Park plant. A chassis was pulled slowly across the factory floor by rope and windlass. Parts and 140 assemblers were stationed along the 150-foot line. As the winch dragged the chassis across the floor, workers attached parts to the car. With this new assembly line, production time for a single vehicle fell from 12 hours and 30 minutes to five hours and 50 minutes.

Soon the line was improved with a power-drive “endless” conveyor system that was flush with the floor and wide enough to accommodate the chassis with room for workers on both sides. By 1914, continuous improvement had whittled the time required for assembly to 93 minutes.

In just 6 years, Henry Ford reduced assembly time by 94% through the implementation of the assembly line. He was able to drastically cut the price of the Model T by making the process more efficient, not by cutting his workers’ pay. In fact, in 1914 he was able to raise the pay of his workers from $2.83 for a 9-hour day to $5.00 for an 8-hour day – enough for a Ford employee to afford a Model T of his own after only 88 days of work.

Now imagine an entire economy becoming more productive through innovation and then passing a significant amount of that extra productivity to employees. This creates a virtuous cycle where employee’s extra purchasing power improves business throughout the entire economy.

Alternatively, consider the situation where costs are lowered through pay cuts. If Ford had continued producing the Model T in the same fashion, but reduced costs purely by cutting workers’ pay, everyone that didn’t work for Ford would be better off, but Ford employees would be worse off. Again, imagine an entire economy reducing costs through pay cuts. As opposed to the first example, this would create a vicious cycle where less purchasing power would weaken the overall economy.

When the price of goods and services decrease due to improvements in productivity we are all better off – especially when improved productivity is passed on to employees. When those price drops occur from falling wages, we aren’t. Today’s economy could use more businessmen like Henry Ford, and fewer like the Walton Family.