What If Big Firms Can Predict Minimum Wage Hikes?

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Introduction

This article is to look at a hypothetical position on how big firms or key industry players may have the ability to predict changes in minimum wage or regulations. In this article, I put forward the proposition that big firms possess asymmetric information allowing them to know, or “predict” with a certain amount of accuracy, when the minimum wage is raised by state or federal authorities.

While this theory is still hypothetical, I will also provide some recent evidence on cases which represent this phenomenon. This article will also look at what do firms do, and how this asymmetric information changes valuations of labor and capital towards the firm.

Obtaining Asymmetric Information

Larger firms have the ability to lobby government officials. It’s no secret that billions of US Dollars have been lobbied from various industries and groups.

Ludwig Von Mises refers to “caste conflicts in which societies generally tend to not have conflicts with each other when a higher degree of market freedom is ascertained; while government-granted privileges allows those who live off the government to divide and drive a wedge between society.

This idea can be further expanded when considering how lobbyists cause bigger firms to have the ability to “live off the government” compared to medium and smaller firms.

With this, we can conclude that not only do larger firms have more “purchasing power” with politicians (in terms of lobbying for rules and regulations), however this can also be expressed in the form of information as well.

First, let’s define what lobbying means.

Lobbying can be described as:

“The act of attempting to influence business and government leaders to create legislation or conduct an activity that will help a particular organization.”

We can also further expand the definition of lobbying. As mentioned above, larger firms with their lobby groups could also hold the potential of “purchasing” information.

Why would a Lobby group want to obtain information? The essential reason on why lobby groups obtain information is because this allows for firms to plan and coordinate their actions in order to prepare for inevitable changes in market environments due to societal changes in morality (example, a higher minimum wage to reflect changes in living cost, or to reflect what is believed as the “Value of Labor” according to those pressure groups).

This, in turn with the asymmetric information obtained from lobbying efforts, allows for larger firms to seize the opportunities not made available to smaller firms.

Take the example of Wal-Mart and raising wages for employees.

With the inevitable fact that the minimum wage will be raised federally (within certain states the minimum wage has already been raised), Wal-Mart essentially raised wages to reflect the value contributed for the current line of employees.

However, what about the future employment of employees down the line? Essentially, Wal-Mart has already cut 7000 jobs due to automation. This in essence shows that Wal-Mart not only reduced its hiring rates, but also cut back in the total amount of jobs being offered on the job market.

The reason for this could potentially be that asymmetric information was obtained by Wal-Mart lobbyists on an estimation of when the minimum wage will be raised. As a result, Wal-Mart has adjusted its labor force, changed their salaries, and continuing to expand their automation process.

A Basic Economics Crash-Course

Before we can continue with our discussion, a small crash course in basic microeconomics is needed in terms of understanding the value of labor and how it changes. Below is a diagram representing the “Marginal Value Product of Labor.”

With the current prevailing wage rate, we receive total employment for the firm or industry at Q1. Now, let’s assume that we have perfect conditions in our hypothetical industry. We must introduce a new concept called “Marginal Value of Capital” (MVPK). This new concept essentially like the last one measures every additional amount of value added per increase of capital goods employed.

As seen in the diagram, the prevailing amount of capital at the current rental rate (the cost of employing capital goods) allows for a firm or industry to employ Q1 quantity of capital.

Now, in a market environment, new technologies form and are employed over the long term. Assuming that no other factors affect the changes in the MVPK (such as changes in revenues, or changes in MVPL), those new technological factors essentially shift the MVPK towards the right, indicating an increase in their value.

As a result, more capital is employed. However, what about the MVPL?

Essentially, an increase in the MVPK will also increase the MVPL. The MVPL also shifts towards the right. The reason on why the MVPL will shift to the right is because when new capital goods are introduced, this will allow for the labor force to utilize new production methods and thus increase their value of production as well compared to the equipment and production methods used previously.

Now that we understand the basics on how changes in technological factors increase the value of labor, we must now turn our attention towards a change in minimum wage laws.

Let’s take an example below of a graph showing MVPL.

With a sudden change in the short term with wages (due to minimum wage legislation), we see that the quantity of labor employed reduces.

Because firms would want to continue to produce at the same output, this would mean that firms must replace Labor with capital goods. However, take into consideration the supply and demand of capital in the short term.

In the short term, capital is fixed/extremely inelastic.

The reason for this is because new factories and technologies can’t magically appear within the short term. Thus, as a result with the increase in demand, this will essentially increase the rental rate for new capital goods as when taking in consideration the law for supply and demand.

As a result, this would change the MVPK in the short term as well. Due to this change in MVPK, we will see firms reduce the amount of capital employed as well.

This would therefore mean, a firm will have to reduce the amount of goods and/or services it provides to the market (this is called the quantity effect), hindering economic growth in the short term by reducing consumer real purchasing power, and reducing profitability of firms. This in turn reduces the potential of profits obtained by investors to be reinvested in new industries elsewhere.

Large Firms Applying New Information

Now that we’ve explored basic microeconomics with wages and capital, let’s go back towards our hypothetical theory on how large firms have the ability to predict minimum wage changes.

Let’s make McDonald’s as our example company.

McDonald’s lobbyist are attempting to prevent congress from introducing an increase in the minimum wage, however, eventually their influences will fail.

Once their influence on congress reduces, lobbyist may have the ability to obtain information about at least when the minimum wage legislation will be introduced and at what moment it would go into effect in the economy as a whole.

With the information obtained, McDonald’s would get to work in order to prepare itself for when the minimum wage will be passed and placed into the economy as a whole.

First, McDonald’s would calculate the “Marginal Value Product of Labor” and at how many employees they would employ if they did nothing within the current timeline, and thus reflect the number of employees required.

Pw represents the predicted wage rate and Pq represents the predicted quantity needed as a result of a minimum wage increase.

Now that McDonald’s has calculated what number of employees should be employed in the future, if they did nothing and decided to take the hit from the quantity effect, the same must be done in terms of capital.

Now that McDonald’s has calculated or at least estimated on how much labor and capital would be needed when the new minimum wage goes into effect (and thus affecting rental rates assuming all other factors are held constant), they now know how much they must invest into new technologies in order to continue to output at the same rate as if nothing ever happened.

Notice how the Predicted Quantity (Pq2) is higher than Q1. Why is it that McDonald’s wants to increase the value of capital to an extent where there’s a higher degree of capital goods being employed?

The reason for this is because the value of labor in real life (compared to our crash course in economics) does not increase at the same rate as the value of capital.

The reason for this is because in real life, low skilled labor production techniques cannot necessarily adapt new capital goods compared to high skilled labor production techniques relative towards the improvement of technology in capital goods.

With the disproportionate increase of MVPL due to the increase of MVPK, we see that McDonald’s will reduce their hiring rates and their total labor force in the future.

As you can see, the due to the unproportionate increase of MVPL and MVPK, McDonald’s from the present day will replace labor with capital (reducing their labor force, increasing their capital goods such as kiosks etc) so that when the anticipated minimum wage hike comes into effect, the trade-off between labor and capital will allow them to produce at the same output.

This will give them a competitive advantage as they will increase their market share due to the fact that the remainder of the competition cannot anticipate the rise in minimum wage at a future date, thus McDonald’s will acquire their reduction of output in terms of percentage of overall industry output.

In real life, due to the disproportionate increase between MVPL and MVPK, McDonald’s must increase the MVPK beyond Q1 so that they can produce at the same output in the future, this is because the MVPL predicted quantity (Pq2) is still lower than Q1, thus Pq2 on the capital side substitutes for Pq2 on the labor side in order to produce at the same output in the future.

Examples of Firms Anticipating Minimum Wage Changes

Now that I’ve explained the basic economics behind labor and capital, and also explained the theory behind how firms anticipate minimum wage increases, I’ll turn our attention towards real life examples of this happening in the process.

First example is already mentioned that Wal-Mart has cut 7000 jobs in favor of automation.

However, why are Wal-Mart and others mentioned in the article pushing towards automation?

Quoted in the article:

“And Wendy’s cited the rising cost of labor and competition among fast food chains as motivation for its own decision to replace some cashiers with kiosks.”

As a result, Wendy’s, like McDonald’s, already made a push towards kiosks.

However, 19 states have pushed towards the increase of minimum wages.

In fact, we can see that McDonald’s as early as 2014 had been planning to replace cashiers with kiosks.

This by itself shows that pre-2014, despite McDonald’s having a poor performance record during this period, the kiosks came into play due to the anticipation of minimum wages being raised in the future.

Now, what about current trends? As shown by the CATO Institute, Shake-shack is currently testing a new automation system which requires no cashiers; where customers receive a text message to pick up their order. The reason for this? It’s due to the high probability of an increase of the minimum wage coming up in 15 to 20 months.

However, while no quantitative work has been assembled on this subject, the qualitative evidence is endless.

We can see that larger fast-food companies, and highly likely large firms in other industries, have the ability to anticipate raises in minimum wages and prepare for the inevitable.

Conclusion

In conclusion, we’ve explored the basics of labor and capital and how one affects the other.

With a rise in the minimum wage, there is an output effect and reduced growth in industries.

When applying the fact that larger firms have the ability to forecast and predict changes in minimum wage legislations due to lobbying power providing them with information from politicians, we see that larger firms prepare accordingly towards what they believe are the anticipated changes in minimum wages.

While the theory may be hypothetical and only qualitative evidence exists for it, once I find the time to work on quantitative workings of the theory, I can then definitely display how the theory is put into the real world.

Many variables must be controlled for, thus, the theory isn’t necessarily the sole reason why firms invest into technology, but it definitely may be a contributing factor.

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Baland Rabayah

Baland Rabayah is a student of accounting and finance at Bangor University and is also pursuing a Graduate Diploma in Economics at the University of London. Baland holds a Diploma in Accounting and Finance from the Bahrain Institute of Banking and Finance. He plans to pursue to continue his studies by doing a master's in economic history and a PhD in Economics. Baland follows a mixture of Chicagoan and Austrian principles in economics, with his influences being Murray Rothbard, Ludwig von Mises, Friedrich Hayek, George Selgin, Lawrence H. White, Peter G. Klein, Ronald Coase, and Milton Friedman. He is currently part of the Being Libertarian Merchandise Project’s management, and runs his own investments. Baland is also the former CEO of MoreTech Bahrain, a start-up company which attempted to launch Bahrain's and the Middle East's first flagship smartphone. He is a racing enthusiast, and regularly races professionally in Bahrain's SWS races.