Being an economist does not (necessarily) make you rich. Just as being rich does not (necessarily) mean you know any economics!

Tim Worstall has a great teaching post:

We’ve an interesting little example here of the counterpoint to that old line about how if economists are all so smart about the economy then how come they’re not all rich? For we’ve clear evidence that you don’t actually need to know anything about economics in order to become rich. Our source here is William Davidow who does appear to have made his pile but who takes, of all places, to the pages of the Harvard Business Review to reveal that he really doesn’t grok economics. I would quite seriously suggest that he have a little sit down with Greg Mankiw of that same fine institution, Harvard, and gain a bit of a clue as to the basics that refute his assertions.

A couple of examples:

We’ve got that infallible marker of someone now getting it, the assertion that Henry Ford started paying $5 a day so that his workers would buy more of his cars. As I’ve demonstrated in these very pages (here) that simply doesn’t work. Not for economic reasons but ones of simple arithmetic. You cannot increase the profits of your own company through the extra sales of your own products that your higher paid employees might make. It just doesn’t work.

The story of the internal combustion engine is even more dramatic. Not only did it create the automotive industry, but Henry Ford shocked the industrial world when he doubled the pay of assembly line workers to $5 a day. Ford reasoned that a higher paid workforce would be able to buy more cars and thus would grow his business.

Think it through just for a moment. You increase the wages of your workforce by $100. They then spend that $100 on your products. So, have you increased your profits? Well, if the only cost your business has is the labour that you employ then you’ve got increased income of $100 and increased costs of $100. It’s a wash then. But if you have any other costs (and it is any other marginal costs) over and above labour then you will be losing money. Imagine your company buys in $50 worth of steel and $50 worth of labour in order to produce each $100 worth of product. Now you’re receiving, through the greater purchasing power of your workers, $100 in revenue. But your extra costs are $100 in extra wages plus an extra $50 for steel. That’s a loss of $50 from having raised your wages.

This simply does not work, any more than pulling yourself up by your bootstraps does. Davidow is a venture capitalist: he simply would laugh at any business plan presented to him that made the above claim. We’ll pay all our workers $100,000 a year and they’ll buy the product and we’ll all be rich! So why is he willing to think that was what happened in the past?

He’s also entirely wrong on the major point that he’s trying to make:

The Internet is one of humanity’s greatest technical advances. Yet compared to great technological inventions of the past, it is also a colossal economic disappointment.

I’m talking about jobs.

Umm, the creation of jobs is not a sign of a successful technology. In fact, technological advancement is the story of the destruction of jobs.

2 thoughts on “Being an economist does not (necessarily) make you rich. Just as being rich does not (necessarily) mean you know any economics!

  1. It’s well established that Ford was trying to prevent a union takeover. Socialist agitators were active at the time, so he shared some of his monopoly profits with workers so they wouldn’t get any crazy ideas. I read a great paper on it in 2006 but can’t seem to find it now.

    • Justin, “preventing a Union takeover is too general. When workers, for example, are being paid exactly the market wage, there is little cost in quitting (or shirking, even at the risk of being fired). In 1913, the year before wages at Ford were doubled, the turnover rate was almost 400%! Ford had to hire more than 50K workers to maintain a level workforce around 13.5K. In 1915, the year after the wage increase the turnover was about 15% AND productivity (from less shirking, less absenteism, ease of attracting better workers, etc) increased about 50%!
      The cost savings (from hiring, training, etc) were huge.
      All in all, a great profitmaking decision.
      And yes, it is possible that a “union threat” triggered the “strategic decision”.

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