Considering a universal basic income

With the economic carnage caused by the lockdown response to the coronavirus crisis, and most governments responding with a much more generous social safety net, many people are wondering about whether it is time to seriously consider a universal basic income (for example, see here and here). However, before we get ahead of ourselves, we need to consider what adopting a universal basic income (UBI) would mean, and what we already know from the limited experiments that have been undertaken so far in developed countries.

In a 2019 article (open access) published in the journal Annual Review of Economics, Hilary Hoynes and Jesse Rothstein (both University of California, Berkeley) do an excellent job of reviewing the academic literature on UBI. The start with the obvious - what is a universal basic income? It seems like an obvious question, but it turns out that when people talk about UBI, they often mean different things. Hoynes and Rothstein note three features of a canonical UBI:

1. It provides a sufficiently generous cash benefit to live on, without other earnings.

2. It does not phase out or phases out only slowly as earnings rise.

3. It is available to a large proportion of the population, rather than being targeted to a particular subset (e.g., single mothers).

It turns out that a lot of UBI proposals depart from this ideal, especially in terms of the first feature (by keeping the payments small, in order to manage the total cost), or the third feature (by limiting who is eligible).

Hoynes and Rothstein then go on to outline the arguments in favour of a UBI, of which there are three main ones:

One motivation commonly offered for adopting a UBI is that the labor market is not delivering, or is not expected to deliver, adequate growth of wages and earnings for the lower portion of the income distribution. This is sometimes presented as the “robots are coming” argument...

A distinct argument for a UBI is that it could replace the current patchwork of transfer programs in the United States, thereby avoiding the high cumulative marginal tax rates implicit in many existing poverty programs, such as cash welfare... According to some, a UBI would radically simplify the transfer system, reducing perverse incentives while still ensuring a minimum level of income for those who are truly unable to work...

...a UBI represents a more comprehensive and politically defensible safety net [than the current patchwork system], one that reaches all of the needy and not just a demographically targeted subset... They argue that a more universalist approach would also reduce the stigma of program participation, simplify cumbersome application processes, and possibly move the conversation away from assessments of the deservingness of the poor...

In the current crisis, the first argument for a UBI becomes overwhelming, but not for the reasons originally proposed. If the labour market is unable to deliver wages at all due to a lockdown, then that makes the case for a UBI much stronger.

Hoynes and Rothstein then outline how a UBI compares with existing social security programmes in the U.S., and only some of that section applies to countries like New Zealand, where the existing social safety net is more comprehensive and generous. However, the takeaway message is important, since it would apply broadly to most social security systems:

In sum, a UBI would have quite substantial distributional and cost effects. A smaller proportion of UBI dollars would go to the bottom of the income distribution compared to the current system, though a generous UBI, with the needed revenue funded by a progressive tax, could increase the absolute size of transfers to the bottom and thus would represent a (potentially very large) downward redistribution of income. Similarly, a canonical UBI would give a larger share of transfers to the nonelderly and nondisabled than the existing programs, so any proposal to finance it through cuts in health and retirement programs — the largest sources of funds in the existing US transfer system — would need to address the large declines in living standards that the elderly and disabled would experience.

The article reviews the literature on the potential labour market effects of a UBI - a key consideration for some, who believe that the work disincentives would be large. Finally, they review the existing literature on the effects of UBI pilot programmes (such as those I have previously discussed here and here), but in general that literature might be summarised as unhelpful, because:

UBIs meeting the definition we laid out above — large enough to live on, and without phaseout or other eligibility restrictions — have never been implemented in a rich country on a large scale or even in a pilot experiment. What we know about the likely effects of a UBI comes from analyses of policies that are similar in some ways to UBIs, though different in others, and from the broader labor supply literature.

Finally, it is impossible to adequately consider a UBI without considering its cost. As Hoynes and Rothstein note in their conclusion:

The source of the new funds is a first-order issue and will have substantial impacts on the distributional effects of the policy and its ability to target those most in need of assistance. In particular, replacing existing antipoverty programs with a UBI would be highly regressive, unless substantial additional funds were put in.

The idea that adopting a UBI could represent a regressive change in the social security system would come as a surprise to many people, I expect. Overall, will a UBI be a saviour for the economy - unless we are somehow able to solve the issue of how to fund it, we may never find out.

[HT: Marginal Revolution, last year]

How long should the coronavirus lockdown last?

Last week, New Zealand moved from pandemic Alert Level 4 to Alert Level 3. On 11 May, we'll find out how long we have to stay at Level 3 before moving to Level 2, which presumably lifts most of the remaining lockdown restrictions (while maintaining physical distancing and the ban on large gatherings). With only a handful of new cases each day (and zero yesterday), it appears that the worst has passed, at least in terms of the public health costs of the pandemic. However, people are now starting to tally up the economic costs of the lockdown and wondering if it was worth it (see here and here for two examples).

Following on from yesterday's post on the economics of COVID-19 policy, let's consider what the optimal period of lockdown would be. In doing so, I'll show why anyone who wanted a longer lockdown, and anyone who wanted the lockdown lifted earlier, are both unable to provide compelling evidence to support their arguments. Let's put aside the question of whether a lockdown should be used at all, and start from a position of a lockdown having been imposed - how long should the lockdown go on for?

In my ECONS102 class next semester, in the very first week we'll talk about a framework for determining the optimal quantity of something, using marginal analysis. Marginal analysis involves considering the marginal benefits and marginal costs, and in this case we're considering the optimal length of lockdown.

The general model is outlined in the diagram below. Marginal benefit (MB) is the additional benefit of one more day of lockdown. The benefits of lockdown include primarily the reduction in public health costs, including morbidity and mortality as a result of COVID-19 infection. In the diagram, the marginal benefit of lockdown is downward sloping - the first day of lockdown provides the greatest benefit in terms of reduced infections (and associated costs). Extra days provide more benefits, but compared with the first day, the marginal benefit is less - that's because, once 'the curve starts to flatten', each day in lockdown prevents fewer additional infections than the previous day.

Marginal cost (MC) is the additional cost of one more day of lockdown. The costs are primarily economic - reduced output for the economy, associated with lower incomes (in total and distributed unevenly in the population). The marginal cost of lockdown is upward sloping - most businesses can survive a few days of lockdown, but the longer the lockdown continues, the more businesses close up permanently, and this process likely accelerates over time.

The 'optimal length' of lockdown occurs where MB meets MC, at Q* days. If the lockdown was longer than Q* days (e.g. at Q2), then the extra benefit (MB) of those additional lockdown days is less than the extra cost (MC), making us worse off overall. If the lockdown was shorter than Q* days (e.g. at Q1), then the extra benefit (MB) of an additional lockdown day is more than the extra cost (MC), so keeping the lockdown going for one more day would make us better off overall.

So, has New Zealand got it right? Are we getting out of lockdown too soon, or too late? The problem is that it is virtually impossible to tell (which is why I said that both sides lack compelling evidence). If you believe that the lockdown is too short, you must believe that we are at Q1. An extra day (or more) of lockdown would save more public health costs than the economic costs it would inflict. If you believe that the lockdown is too long, you must believe that we are at Q2. An extra day (or more) of lockdown would cost more economically than the public health costs it would save.

To come to either conclusion, you would have to be able to assess the economic costs and the public health costs of both alternatives - what would happen with, and without, the lockdown continuing. As I briefly mentioned yesterday, and will be apparent to anyone who has been following the emerging and ever-updating research on the modelling of the pandemic, the current models of the pandemic largely fail to agree on anything. To get an estimate of the marginal benefit of an additional day of lockdown, you need to know not just how many infections would be averted tomorrow, but how many through the remainder of the pandemic as a whole (since an infection averted tomorrow, means one fewer person who can infect others in the future, etc.). The uncertainty in the models renders that a fairly fruitless exercise. And that's before we even consider the uncertainty in the marginal benefits (and the potential for interaction between the two, because an infection averted tomorrow could actually improve the economy overall - consider the infection of an essential worker, as one example).

So, if the marginal benefit of lockdown is highly uncertain, and the marginal cost is also uncertain, then we really have no way of knowing for sure whether the lockdown has been too long, or too short. So, anyone claiming they know the answer is really talking out of a lower orifice. While there is definitely an optimal lockdown length, and we can define what it would be in theory, in practice this isn't a question that can be answered with any certainty - we don't have the data, and we don't have the models, to do so.

And in situations of high uncertainty like this, it might be tempting to invoke the precautionary principle - to be cautious and avoid making a decision with the potential for long-term negative consequences (essentially, this was one approach that Mulligan et al. noted in the article I linked to yesterday - 'buying time'). However, it isn't clear whether it would be better to be precautionary in relation to public health costs (and err on the side of having a lockdown that lasts too long), or to be precautionary in relation to the economic costs (and err on the side of having a lockdown that is too short).

I definitely don't envy the decision-makers on this one. This is genuinely one of those times where, no matter what decision is made, there will be a large number of vocal critics, who can't prove their argument is correct, but equally can't be proven wrong either.

Read more:

• The economics of COVID-19 policy

The economics of COVID-19 policy

I've spent dozens of hours reading up various analyses of the COVID-19 pandemic, economic impact, public health responses, and policy options. Most of what I've read is pretty interesting. However, a lot of it suffers either from being very lightweight in terms of considering the trade-offs (economic cost vs. human health cost). I'll talk a little bit more about that in my next post. However in the meantime, this article by Casey Mulligan, Kevin Murphy, and Robert Topel (all from the University of Chicago) is by far the best that I have read so far.

Mulligan et al. do a great job of laying out the policy trade-offs in a clear way, outlining what we know and what we don't know, and working through the implications of the main policy alternatives. The article is quite details and difficult to excerpt from, so here is their own summary from near the end of the article (emphasis is mine):

Our analysis indicates that the features of a cost-effective strategy will depend on both current circumstances and how we expect the pandemic to play out. Some elements are common, such as the desire to use STTQ [Screen, Test, Trace and Quarantine] rather than LSSD [Large-Scale Social Distancing] when infection rates are low, and shifting the incidence of disease away from the most vulnerable. These apply whether the objective is to buy time, manage the progression of the disease, or limit the long-run impact of a pandemic that will run its course. The key difference in terms of the optimal strategy is whether our focus is on keeping the disease contained. If the objective is to buy time, then our analysis favors early and aggressive intervention. This minimizes the overall impact and allows for strong but scalable measures via STTQ. In contrast, limiting the cumulative cost of a pandemic that will ultimately run its course argues for aggressive policies later, when they will have the biggest impact on the peak load problem for the health-care system and when they will have the greatest impact on the ultimate number infected. Given the desire to protect the most vulnerable, this objective can even argue for allowing faster transmission to those that are less vulnerable, which further limits the burden on the vulnerable and also reduces the burden on the health-care system... Finally, the objective of long-run containment calls for an effective STTQ strategy applied early to keep the overall infection level low. Starting early lowers overall costs and lowers cumulative infections under the long-term containment strategy.

The bolded bits demonstrate that the optimal approach depends on the policy-makers' objective: to buy time, or to limit the cumulative cost of the pandemic. It isn't at all clear which approach is better, and even after the pandemic is over we probably still won't know. One of the important parts of this article is the acknowledgement that buying time allows us to wait until we have better information on which to base decisions.

I encourage you to read the whole article, which as I said is by far the best that I have read so far. Having said that, I wouldn't take their modelling too seriously - I really don't think that there is any model as yet doing a good enough job while incorporating sufficient heterogeneity in the population in terms of infection risk and behavioural response. However, the way that Mulligan et al. frame the issues and work through them is important and to my mind this provides a model for how we should be thinking about these issues.

[HT: Marginal Revolution]

It's going to be a good time to buy a used car, if you're able to

This week in my (online) ECONS101 class, we covered supply and demand. So, it was interesting to see this opinion piece by David Linklater in the New Zealand Herald on Thursday:

What will happen to the New Zealand car industry once the country gets back to some kind of normality (also known as level 2, level 1… no level)? More to the point, will it suddenly be a buyers' market big-time for those still in a position to purchase?

The truth is that nobody in the Kiwi industry knows at this stage.

That last sentence is only correct in the sense that no one knows exactly what will happen. However, the article itself pretty much tells us what will happen. Let's just consider the market for used cars. The article says:

A month of virtually no sales has corrected any supply issues for new and used; that and the dire situation rental car firms are in, with the potential need to offload thousands of unwanted near-new cars.

So in the very short term, it's fair to say this is very much a buyers' market. Dealerships have stock and they're very motivated to move it as quickly as possible. There will certainly be fewer buyers thanks to the economic impact of Covid-19, but those who are left will be tempted with a lot of choice and great incentives. The ships didn't stop coming just because New Zealand went into lockdown; the cars still came.

So, we can expect a decrease in the demand for used cars. With unemployment looking like being at record levels, consumers aren't looking to take on debt or blow their savings on updating their vehicle (even if some may prefer to drive rather than take public transport), so the demand for used cars is likely to decrease. On the other hand, rental car companies suddenly have lots of cars that no one is renting, so they'll likely be looking to offload some of that stock, meaning that the supply of used cars is likely to increase.

The combined effects of those two market changes (a decrease in demand and an increase in supply) is illustrated in the diagram below. The market starts at equilibrium, where demand is D0 and supply is S0. The equilibrium price is P0 and the equilibrium quantity of used cars traded is Q0. Demand decreases from D0 to D1, and supply increases from S0 to S1. The price of used cars decreases to P1. The change in the quantity of used cars traded is ambiguous though - it could increase, decrease, or (unlikely, although this is what the diagram shows) stay the same. What happens to quantity depends on the relative size of the shifts in demand and supply.

So, we can be fairly sure that the price of used cars is about to fall in New Zealand. If you're secure enough, it will soon be a good time to upgrade your car. As Linklater said, "this is very much a buyers' market".