Modeling the effects of UBI

UBI, or Universal Basic Income, is a topic which has growing interest.  Some people think it is inevitable as we transition into a world where technology makes supply so abundant relative to labor that it is the only way to include the average person in the modern economy, ending in a Wall-E type world where the robots produce everything for its human passengers on a cruise ship out in space.  Other people think it is terrifying and would quickly spin out of control into a hyperinflationary collapse, noting the Weimar Republic, Zimbabwe, and Venezuela.  Regardless of your opinion on the matter, it does raise some fascinating questions.

UBI can be instituted in a number of ways, but the most common is the idea of giving an equal monthly payment to every US Citizen which is treated as taxable income. The only question of eligibility and relative amount is whether you have a social security number.

Small-scale experiments to date

There have been a number of small-scale experiments to date on the effects of UBI, focusing on giving a small group of people a monthly payment for a period of a year or so and focusing on how they spent that money and the overall effects on their lives.

Unfortunately, these small-scale experiments can’t really answer any of the underlying questions about UBI.  Everyone knows that getting a small cash windfall tends to make people happier, reduce their stress levels, and so on.  The question is what happens when everybody gets paid a small amount every month.  The first question is the effects on overall demand, because people spend money and plan differently when they have a reliable long-term income rather than having a short-term windfall.  The second and more important question is what happens with inflation?  People have vastly different opinions about what causes inflation and whether it is a linear phenomenon. 

What causes Inflation?

In a previous blog post, I wrote about what causes inflation here: https://johnonstocks.wordpress.com/2020/08/16/what-causes-inflation/

For this post, I put together and attached this chart:

As you can see, the last sustainable bout of double-digit inflation as measured by the CPI was back in the 1970’s.

The Vietnam Draft as a model for UBI

In the 1960’s, two very important things happened: The Greater Society infrastructure spending, and the Vietnam War.  This is a very interesting test case for the effects of UBI because it effectively paid a lot of people incomes for work which had nothing to do with meeting demand for consumer goods and services.

The draft really started to ramp up these mass-UBI payment effects from 1969-1975.

Inflation didn’t really start to accelerate until 1973, when OPEC proclaimed an oil embargo targeted at all nations supporting Israel, causing oil prices to quadruple in less than a year. 

This inflation peaked in 1974, a full decade after that massive UBI-scale money was going out.  This was the date of the important Bretton Woods conference where the US dollar and the world effectively de-coupled from the price of Gold. 

After 1974, CPI inflation actually declined from double digits back to 5%. Then it accelerated rapidly following the heavy oil disruptions from the start of the Iranian Revolution in January 1978 and peaked at nearly 15% in 1980.  Volcker, appointed fed chair in 1979, was credited for beating this inflation as the CPI dropped below 5% in 1983 and has rarely hit that level since.  At the same time, oil collapsed between 1980-1986. During 1979-1981 alone, oil demand collapsed 13% as countries adjusted to higher oil prices by diversifying electrical grids away from oil while fuel efficiency rapidly increased.

As you can see, a lot happened to cause the inflationary spikes during the 1970’s.  So how does this relate to UBI?  There is still an enormous debate on the biggest underlying cause of the 1970’s inflation, with many arguing that the wage-price spirals went out of control due to the tight labor market and the powerful labor unions.  Others argue about cost-push inflation from the oil shocks, or supply disruptions combined with heavy war-related demand, or monetary debasement culminating in abandoning of the gold link at Bretton Woods.

I would argue that if you took the annual Vietnam war spending and applied that same level of money to a UBI, than the result would be only the level of inflation attributed to the wage-cost spiral effect during the 1970’s.  Thus inflation would not only be limited to the levels seen during that decade, but would be substantially lower because it would not cause the other inflationary effects of the 1970’s.

How would we pay for UBI?

The most common question about UBI as how would we pay for it? In order to model that you have to ask how do we pay for anything?  We spent enormous sums in WW2 in the 1940’s after a decade of great depression, to be followed by rapid growth in the 1950’s and 1960’s. We spent enormous sums in Vietnam as well, also followed by rapid growth in the 1980’s and 1990’s.  Here is a chart of overall government debt over the years, source: https://www.thebalance.com/national-debt-by-year-compared-to-gdp-and-major-events-3306287

End of Fiscal YearDebt (in billions, rounded)Debt-to-GDP RatioMajor Events by Presidential Term
1929$1716%Market crash
1930$1617%Smoot-Hawley reduced trade
1931$1722%Dust Bowl drought raged
1932$2034%Hoover raised taxes
1933$2340%New Deal increased GDP & debt
1934$2740% 
1935$2939%Social Security
1936$3440%Tax hikes renewed depression
1937$3639%Third New Deal
1938$3742%Dust Bowl ended
1939$4043%Depression ended
1940$4342%FDR increased spending & raised taxes
1941$4938%U.S. entered WWII
1942$7243%Defense tripled
1943$13767% 
1944$20190%Bretton Woods
1945$259114%WWII ended
1946$269118%Truman’s 1st term budgets & recession
1947$258103%Cold War
1948$25292%Recession
1949$25393%Recession
1950$25786%Korean War boosted growth and debt
1951$25574% 
1952$25971% 
1953$26668%Recession when war ended
1954$27169%Eisenhower’s budgets & Recession
1955$27464% 
1956$27361% 
1957$27157%Recession
1958$27657%Eisenhower’s 2nd term & recession
1959$28555%Fed raised rates
1960$28653%Recession
1961$28951%Bay of Pigs
1962$29849%JFK budgets & Cuban missile crisis
1963$30648%U.S. aids Vietnam, JFK killed
1964$31246%LBJ’s budgets & war on poverty
1965$31743%U.S. entered Vietnam War
1966$32039% 
1967$32638% 
1968$34837% 
1969$35435%Nixon took office
1970$37135%Recession
1971$39834%Wage-price controls
1972$42733%Stagflation
1973$45832%Nixon ended gold standard & OPEC oil embargo
1974$47531%Watergate & budget process created
1975$53332%Vietnam War ended
1976$62033%Stagflation
1977$69934%Stagflation
1978$77233%Carter budgets & recession
1979$82731% 
1980$90832%Volcker raised fed rate to 20%
1981$99831%Reagan tax cut
1982$1,14234%Reagan increased spending
1983$1,37738%Jobless rate 10.8%
1984$1,57239%Increased defense spending
1985$1,82342% 
1986$2,12546%Reagan lowered taxes
1987$2,35048%Market crash
1988$2,60250%Fed raised rates
1989$2,85751%S&L Crisis
1990$3,23354%First Iraq War
1991$3,66560%Recession
1992$4,06562% 
1993$4,41164%Omnibus Budget Act
1994$4,69364%Clinton budgets
1995$4,97465% 
1996$5,22565%Welfare reform
1997$5,41363% 
1998$5,52661%LTCM crisis & recession
1999$5,65659%Glass-Steagall repealed
2000$5,67455%Budget surplus
2001$5,80755%9/11 attacks & EGTRRA
2002$6,22857%War on Terror
2003$6,78359%JGTRRA & Iraq War
2004$7,37960%Iraq War
2005$7,93361%Bankruptcy Act & Katrina.
2006$8,50762%Bernanke chaired Fed
2007$9,00862%Bank crisis
2008$10,02568%Bank bailout & QE
2009$11,91082%Bailout cost $250B ARRA added $242B
2010$13,56291%ARRA added $400B, payroll tax holiday ended, Obama Tax cuts, ACA, Simpson-Bowles
2011$14,79095%Debt crisis, recession and tax cuts reduced revenue
2012$16,06699%Fiscal cliff
2013$16,738100%Sequester, government shutdown
2014$17,824102%QE ended, debt ceiling crisis
2015$18,151100%Oil prices fell
2016$19,573104%Brexit
2017$20,245104%Congress raised the debt ceiling
2018$21,516104%Trump tax cuts
2019$22,719106%Trade wars
2020$27,748129%COVID-19 & CARES Act

Notice that the dollar amount of US government debt never declines after 1951, even in our so-called government surplus year in 2000. Between 1940-1945 it went up 600% while debt/gdp went from 38% to 114%. Over the following decade (1945-1955), US debt barely budged and debt/gdp was cut in half. Contrast this to the Vietnam war where debt only went up 68% and debt/gdp went down from 43% in 1965 to 32% in 1975.  How did that happen?

Perhaps it went to the central bank balance sheet? https://www.stlouisfed.org/publications/regional-economist/january-2014/the-rise-and-eventual-fall-in-the-feds-balance-sheet

Note that this is the central bank balance sheet/GDP, but it is still interesting that this measure actually declined in both WW2 and the Vietnam war.  Compare that to today where the central bank balance sheet more than doubled between July 1, 2019 and July 1, 2021 while US GDP went from $21.4T to $22.7T bringing us to a debt to gdp of $8T / $22.7T = 35%. 

However you look at it, the only thing that seems to stand out in periods of heavy government spending related to these wars was the periods of higher inflation.  It looks like its fair to say that we ultimately paid for these wars with inflation, and that a UBI program would be paid for in the same way.

Why do central banks want higher inflation? How have they been reacting? Are their policies working?

The US Central bank in particular has a mandate to achieve full employment as well as price stability.  In order to achieve full employment, we need to have continuous growth to at least match the growth in population.  The idea is that in a deflationary period, prices are going down because demand is lower than production, so production needs to decrease and employees are laid off.  Contrast this to a period of inflation which signals to the economy that more production is needed and people are hired in order to achieve it.

Sounds simple, right? How well does this work in practice?

The above chart shows the labor force participation rate for prime working age 25-54 declining steadily since 2000.  In fact, the labor force never even recovered from the great financial crisis before the covid crisis hit.  This is despite the Federal Reserve trying to “create inflation” by pegging interest rates near zero and increasing the size of it’s balance sheet via “quantitative easing”

Why isn’t this working?  Rents have definitely been increasing.  Housing prices have been going up.  Asset values in general have climbed at a rapid pace with this policy:

Has production decoupled from the labor force? Has the stock market as well?  In a word, yes. With automation and globalization, it takes a lot less labor for a company to generate the same earnings:

The above chart should be more empowering than it is shocking.  We have more productivity than ever before – we just need to figure out how to allow the labor force to participate.

Supply side vs demand side economics

Supply side economics has a long history on its side.  During the amazing productivity booms of the Industrial Revolution, the expansion of global trade led to a world of seemingly limitless demand for products. Factories were being built for everything, and anything produced was sold.  Andrew Carnegie used the famous Bessemer process to create the world’s biggest steel manufacturing plant, borrowing all he could to finance it’s construction.  One it was built, the sky was the limit as skyscrapers began to fill US cities creating nearly limitless demand for his products.  During this time, manufacturing was very labor-intensive and more production meant more factories filled with more workers.

Contrast this to the amazing computer age, where productivity could grow by leaps and bounds while the workforce was pruned.  We’ve had an increasing problem of excess productive capacity for decades:

Where do we go from here?

We have more productive capability than ever and nowhere near enough demand to meet it.  Sounds like a success problem right?  Not so fast… remember the problems of labor force participation among prime working age adults. Think of the rapid growth in our homeless populations over the last decade, along with the deaths of despair.  We have a system that treats people as a commodity called “Human Resources.” When a commodity is in oversupply, less is needed – hence the decline of our labor force and our birth rates as political unrest soars.

There are many ways we can solve this problem, and a UBI is only one of them.  Others include employment guarantees, with the idea that it is better to have employees in money-losing government owned enterprises than unemployed protesters on the street.  There are a lot of useful and creative activities that we can incentivize people to do whether it’s environmental cleanups, infrastructure building, scientific research, or artistic endeavors.

With our current focus on debt levels, it seems that our many problems are insurmountable.  How will we ever modernize our infrastructure?  How will we pay for our people’s retirements?  How will we provide decent health care to our lower wage workers?  How will we protect and restore our environment?  It seems ironic that our problems stem from a world of excess capacity.

We have had problems with debt and spending many times in the past.  These have tended to resolve with periods of mild inflation followed by rapid growth.  Currently, we have a federal government that is focused extensively on minimizing the debt alongside a central bank which is trying desperately to fix the labor market by throwing money into inflating asset values.  Perhaps we could replace this counter-productive activity with a different solution.

About johnonstocks

I've been trading stocks since 2003, active on Motley Fool's discussion boards and using first Hidden Gems, then Global Gains. I no longer have the newsletters, but I keep up on the WSJ and read David Rosenberg everyday at gluskinsheff.com. Education: CFA level 2 candidate MBA-focus in Finance, Marshall, University of Southern California - expected Dec 2010. BS Mechanical Engineering, UC San Diego, June 2002
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