In an effort to stop the migration of many of the automobile manufacturing facil

Question

In an effort to stop the migration of many of the automobile manufacturing facilities from the Detroit area, Detroit's city council is considering passing a statute that would give investment tax credits to auto manufacturers. Effecively, this would reduce auto manufacturers' costs of using capital and hihg-tech equipment in their production processes. On the evening of the vote, local union officials voiced serious objections to this statute. Outline the basis of the arguement most likely used by union officials. (Hint: Consider the impact that the statute would have on auto manufacturers' capital-to-labor ratio). As a representative for one of the automakers, how would you counter the union official's arguement?

Explanation / Answer

An investment tax credit would reduce the relative price of capital to labor. Other things equal, this would increase w/r, thereby making the isocost line more steep. This means that the cost-minimizing input mix will now involve more capital and less labor, as ?rms substitute toward capital. Labor unions are likely to oppose the investment tax credit since the higher capital-to-labor ratio will translate into lost jobs. You might counter this argument by noting that, while some jobs will be lost due to substituting capital for labor, many workers will retain their jobs. Absent the plan, automakers have an incentive to substitute cheaper foreign labor for U.S. labor. The result of this substitution would be a movement of plants abroad, resulting in the complete loss of U.S. jobs.

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