# Whither now for Austerity Measures?



## onq (25 Aug 2011)

A recent article by Robert Reich suggests what every layperson can see.

More austerity will drive us deeper into recession.

We shouldn't confuse balancing the books with crippling the world economy.

http://robertreich.org/post/9142270982

"Repeat after me: Workers are consumers. Consumers are workers."

"Every CEO of every company that continues to squeeze payrolls (Verizon,  are you listening? Ford?) needs to understand they’re shooting  themselves in the feet. Where do they expect demand for their products  and services to come from?"

"They’re doing the reverse of what Henry Ford did back in 1914 – paying  his workers three times what the typical factory employee earned at the  time. The _Wall Street Journal _called his action “an economic  crime” but Ford knew it was a cunning business move. With higher wages,  his workers became his customers, snapping up Model-Ts and generating  huge profits."


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## Firefly (25 Aug 2011)

Hi ONQ,

This doesn't make any sense to me...At best it's a zero sum game (which would assume that each worker spent *all* of their "extra" income on Ford cars (without even taking tax into consideraion)). If the workers spent even 1% of their "extra" wages on something other than new Ford cars, surely it would have made more sense to just give his employees free cars instead rather than see any of the money go elsewhere?

It would be like sending your wife into town with 300 euro to buy you a new suit. If she spends all of the money on a suit you are no better off...you now have something worth 300 euro for your money. If on the otherhand she bought a suit for 250 euro and the rest on a handbag (for herself!) then you are down...you should have gone into town yourself.


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## onq (25 Aug 2011)

I think you'll agree that periods of growth occur in every economy.
This usually happens when consumer confidence grows and people start spending instead of saving.
This present government, in conjunction with many others, seems determined to make people to afraid to spend.

This is no way to deal with a recession - it will make it worse.

As for the zero sum game, you must know that with the multiplier effect that is not the case.

 BTW your example seems to be incorrect, even if your wife bought you the suit you asked for.
If you buy a suit at a cost of €300 you now have a second hand suit that once cost €300, but that you cannot get €300 for if you tried to sell it.

Personally, I'd take the €250 Euro suit and a happy wife any day.


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## Firefly (25 Aug 2011)

onq said:


> As for the zero sum game, you must know that with the multiplier effect that is not the case.
> 
> BTW your example seems to be incorrect, even if your wife bought you the suit you asked for.
> If you buy a suit at a cost of €300 you now have a second hand suit that once cost €300, but that you cannot get €300 for if you tried to sell it.


OK..the suit was a bad example. Say you asked her to buy you a  one-for-all-voucher for 300 euro. If she buys you one for 300 euro,  you're none the richer, but if she spend some money on something else  for herself then you lose. Similiar to how Ford would be if their  employees spend the extra income on anything other than Ford. So I can't see how this helped Ford (unless the extra cars out on the road encouraged others to buy). 




onq said:


> Personally, I'd take the €250 Euro suit and a happy wife any day.



I'm with you there . It could even be one of these http://t0.gstatic.com/images?q=tbn:ANd9GcQMUez4LTDXbKTszO6jpRBGxCuble9VIEwjCwaJ4SOXBePt4nRgTg


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## onq (25 Aug 2011)

It doesn't work like that.

The ford employees had additional income per unit time.
They didn't need to spend all their income buying the cars
They weren't the sole people in the economy buying ford cars.
They made many times more cars than the one they bought to use.

Therefor in earning the money to buy one car, they contributed the labour to make many cars, some of which they bought.
The significant additional wages they earned didn't all go on buying their cars and contributed to the improvement of the economy as a whole.

ONQ.


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## Firefly (26 Aug 2011)

Obviously some extra cars were bought by Ford staff but paying staff more money just so that they will buy more of your product doesn't add up. If it was that easy then why doesn't every company just start paying people triple?


Lets look at the how profits are made. 

Lets take nominal sales of 10m (i.e. the sales that would have been reached without the extra payment to staff). 
Cost of sales as 5m (lets assume these are static even though they would rise if more cars were purchased by staff earning more)
Industry average wages 100K.


Normal Profits for workers on the typical factory rate

Sales                               10,000,000
-Cost of sales               5,000,000
Gross Profit                   5,000,000

Less Expenses
 Wages                100,000
*NET PROFIT                       4,900,000*


Now Ford decides to pay its workers 300k.

Scenario 1. Ford workers spend all of that extra 200k on Ford cars. 
(Sales rise to 10.2m and wages rise to 300k)

Scenario 2. Ford workers spend half of that extra 200k on Ford cars. 
(Sales rise to 10.1m and wages rise to 200k)

* Scenario 1        Scenario 2*
Sales                                10,200,000    10,100,000
-Cost of sales                5,000,000      5,000,000
Gross Profit                    5,200,000      5,100,000

Less Expenses
 Wages                                        300,000       300,000
*NET PROFIT                         4,900,000     4,800,000*
 

From this we can see that in scenario 1 Ford is no better off and in scenario2 Ford actually loses money.

Now, if Ford decided that by paying extra to it staff it could attract more efficient staff who produced more output then great, but your article doesn't say that. 

Perhaps I am missing something?

Apologies for the formatting..can't seem to get it neat


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## Sunny (26 Aug 2011)

Henry Ford's move was a cunning business move but it had absolutely nothing to do with staff becoming his customers. The only reason Ford introduced the pay rise was for business reasons. He was losing huge amounts of staff from the production line which was damaging productivity. He introduced the $5 day to steal his competitors best employees and to keep staff from leaving.

By the way the $5 a day was highly conditional on you being a good person. Ford had a social department that investigated employees to make sure they weren't indulging in any vices such as gambling and drink.


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## Purple (26 Aug 2011)

Sunny said:


> Henry Ford's move was a cunning business move but it had absolutely nothing to do with staff becoming his customers. The only reason Ford introduced the pay rise was for business reasons. He was losing huge amounts of staff from the production line which was damaging productivity. He introduced the $5 day to steal his competitors best employees and to keep staff from leaving.
> 
> By the way the $5 a day was highly conditional on you being a good person. Ford had a social department that investigated employees to make sure they weren't indulging in any vices such as gambling and drink.



He also had a more efficient method of production so would afford to pay his staff more while still keeping his unit costs down. 

The whole argument for stimulating the economy through consumer spending doesn’t work here. We export most of what we produce and import most of what we consume. Joe public spending more money on consumer goods results in cash flowing out of the economy. We need the opposite to happen. Where we were was unsustainable, we were never as well off as we thought we were, so there’s no going back. We have to become competitive again and that’s going to involve lots of pain, emigration and years of high unemployment. There’s no getting around that.


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## Firefly (26 Aug 2011)

+1 to Sunny and Cher (I mean Purple ). Ford paid extra to attract the best workers and had an advanced manufactoring process. This resulted in higher profits rather than merely paying its workers more money to buy its own products. The same can also be said for anyone in receipt of money from the government...unless it ALL goes back to the government then it costs the taxpayer money.


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## Chris (26 Aug 2011)

ONQ, you are again listening to completely fallacious arguments from one of the most delusional neo-Keynesians, second only to Krugman. 
Production comes first, then comes spending, *not* the other way around. I have previously given this basic analogy:
Let's bring this down to the simplest form of economic example, i.e. a Crusoe example. Imagine a man ship wrecked on an island. His demands for everything from water, food, shelter, a TV and other luxuries are huge. In order to satisfy those demands he first has to put in the work to either produce them himself, or produce something that he can use to exchange with the locals. Production always comes first, then comes consumption.

Creating artificial demand is the easiest thing that can be done, just send everyone a cheque to spend; but reality doesn't work that way.

You also have to understand what savings are and what they do before you say "I think you'll agree that periods of growth occur in every economy.
This usually happens when consumer confidence grows and people start spending instead of saving."
Jobs are created by entrepreneurs when two things are present, (a) the prospects of profits and (b) the availability of capital. When people spend their savings this means that there is less capital available. So when you hear politicians and people like Reich say that people should spend more, then what they are effectively saying is that we need to reduce the amount of capital available to businesses, which means that less jobs can be created. This is precisely why Germany has weathered the crisis pretty well. Germans save a lot of money, which means there is a lot of money available for businesses to create jobs.

While many western countries are talking of austerity, none of this has actually been achieved. Austerity should result in smaller deficits and a reduction of debts. The Irish deficit went down last year, but is expected to go up again this year, while debt levels are ever increasing. Greece is failing in meeting its deficit reductions and its debts are growing. The US has done the very opposite of even thinking about reducing spending, and it has had absolutely no positive effect on the real economy. I challenge you to find one period of history where the opposite of austerity has actually worked.

Sunny and Purple are 100% correct. Ford was operating at a time of huge industrial expansion where he had to compete with other companies for workers of varying type of skills. His motivation was to retain people that had skills in operating his machinery and attract other skilled machine operators that would make him more productive than competitors. It was because of productivity that sales increased, and because of that profits went up and because of that wages increased. Wage increases were not the cause of increased sales. As already pointed out, if wage increases cause economic expansion then governments would only have to introduce a law by which employers had to give everyone an annual pay rise of say 20%. All this would achieve is a long line of bankruptcies and massive unemployment.


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## Purple (26 Aug 2011)

To add to Chris's points if people are forced/encouraged to spend rather than save then capital will flow out of the country. If people continue to save they will worry about the collapse of their Irish bank and capital will flow out of the country. If we want to stimulate the economy we have to make it a more attractive place for capital to flow into. We do that by reducing costs and balancing our books thereby facilitating a profitable return on investments. 

Government stimulus is what happens when capital is in flight.


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