MYTH: Henry Ford paid his workers double the market rate so they could afford the products that they were paid to make. This is why we need a "living wage."
REALITY: Henry Ford paid these “efficiency wages” to lower the rate of turnover, absenteeism and the associated costs to the firm from either. The competitive free-market is why he raised his wages.
Henry Ford—who had paid his employees a competitive $2.25-2.50, struggled to maintain a satisfied workforce. Ford revolutionized manufacturing with the assembly-line production process, and in a period from 1908-1914, the composition of his workforce changed. The relative speed Ford could produce cars due to standardizing of parts and the specialization of his labor force, reduced the need and costs of skilled craftsman in the production process.
The change in skill level demanded for labor increased greatly the labor supply, and surprisingly, the turnover rates as well. For every 100 positions open, Ford had to hire 370 workers just to keep them filled. Absenteeism had reached 10% a day, further adding to production losses. One would think that with such high demand for these jobs, along with competitive market wages, it would satisfy the requirements to retain and elicit effort from his workforce, but this just wasn’t the case.
Implicit in these high turnover and absenteeism rates are losses incurred by Ford Motor Company. Search costs are those incurred by firms for finding a suitable employee to hire. Moreover, advertising, screening applications and interview processes take time and cost money. Even in low-skilled occupations, almost 22 person-hours are required to fill a vacancy. Even after an employee is hired, general or specific training is often needed before workers are able to produce commensurate with their pay, this training also makes them valuable to competition and their loss more costly to their employer.
By 1914, Henry Ford instituted a 5 dollar a day wage, available only to employees that had been with the company for at least six months. At the same time, only those job applicants that have been living at least six months in the Detroit area would be considered for employment. In the period of March 1913 to March 1914, the quit rate at Ford decreased by 87% and discharges decreased by 90%. Similarly, the absentee rate dropped by 75% from October 1913 to October 1914. Though, this wage increase perhaps didn’t help Ford maximize profits, it did raise morale, effort and productivity.