Some Thoughts on Innovation and the UBI (From Econversations 2-28

Innovation

 

So most of you have probably heard of the trolley problem. But for those of you who haven’t, it goes like this: you are in an out of control trolley careening toward five people on the tracks. You cannot stop the trolley, you cannot get the people out of the way. The only thing you can do is operate a track switch. If you switch tracks, you will head down a track with only one person on it.

 

Many people will respond, “well, if you switch tracks, then you are killing fewer people, so you should switch tracks.”

 

“But,” whoever has posed the question might ask, “what if the one person will go on to cure cancer?”

 

Besides really hating the person who asked because you didn’t sign up for this thinking through your fundamental ethical beliefs nonsense, the moral of the story is that people’s potential matters. That the capacity to innovate matters.

 

The economy still has major barriers to innovation. One such barrier is resistance general resistance to change. A central consequence of innovation is a concept known as creative destruction, which essentially the idea that creation and destruction are not necessarily opposites, or mutually exclusive. Sometimes to create something, you have to destroy the components, and sometimes, creating something replaces something else. Invention is revolution.

 

Think of it this way:

 

SELF-DRIVING CARS!!! NEATO!!!! THINK ABOUT HOW MANY ACCIDENTS THAT COULD PREVENT IF WE TAKE HUMANS OUT OF THE EQUATION!!! TECHNOLOGY IS SO COOL!!!!

 

Unless you’re a truck driver, a cab driver, an uber driver, etc.

 

 

AW, MAN NETFLIX IS THE BEST. THAT WAS TOTALLY INGENIOUS AND A GREAT THING FOR EVERYONE.

 

Except Blockbuster.

 

Think about what AUX cords did to radio, what iPods did to CDs, and for that matter, what CDs did to records.

 

Some resistance to creative destruction is cultural. Policy makers might not support public investment in automation technologies that would be unpopular with their constituents, or alternative energy research in areas whose main industries are mining, fracking, or drilling. Interestingly, countries like Sweden that have expansive social welfare systems are significantly more pro-innovation because they are unafraid of job loss. Peter Goodman reports in the New York Times Magazine that 72% of Americans are “worried” about robots and AI, while 80% of Swedes have positive views on the subject. The Swedish system, featuring large unemployment benefits and comprehensive job training makes people feel secure. That said, many economists fear that we are approaching a precipice: a wave of mass automation that could overwhelm even the social safety nets as large and in depth as the Scandinavian systems. Essentially, we have to face down the reality that the destruction might be faster than the creation.

 

Some resistance to creative destruction is simply economic reality. Economies of scale are a huge factor for almost any innovating industry. Think about how much money goes into pharmaceutical R&D. Think about the kind of facilities and equipment you need, the kind of relationships with insurance companies you need. Competing with a pharma giant is really hard. Think about a social network that already has a huge user base. Any new social media site or program has to draw that kind of interest before they can start profiting through ads and data, which are the major revenue streams for social networks. Cost wise, competing is unbelievably hard. Those companies also have to convince potential customers to move away from companies with significant brand recognition, brand trust, and market power, often in a saturated market.

 

Sometimes those corporate giants actively combat creative destruction, either by buying out startups early on or by trying to create legal barriers.

 

Creative destruction can also be stalled through illegal means. For instance, dumping is the illegal practice of flooding the market with goods being sold below costs by companies who can afford to take a loss, which forces other businesses out of the market and effectively makes the firm a monopoly—who can now gouge prices. In a surprisingly applicable but totally fictional example, last week’s episode of DC’s Legend’s of Tomorrow, set during the cold war, some oil tycoons hired an assassin to kill a scientist who had discovered cold fusion because it would have put them out of business. So you know, not terribly realistic, but it gets the rationale across.

 

In addition, we have a major issue strangling innovation that is far more subtle, and, in my opinion, far more concerning. A study from the Equality of Opportunity Project, lead by Raj Chetty and his merry band of high profile economists, shows appalling results about who is likely to become an inventor (the full study is here, and a summary article is here). Using third grade math scores as a proxy for general skill, the study shows that overwhelmingly the inventors are rich, white, and male, regardless of their aptitude. While high aptitude children of high socioeconomic stature were significantly more likely to become inventors than lower aptitude children of the same income class, high and low aptitude children from low income families were equally likely—or unlikely, as the case may be—to innovate. The study also showed the importance of role models: children who grew up in cities with a lot of innovation were more likely to become inventors, and a large number of existing female inventors in the city increased the numbers of future female inventors in that area(the same goes for men). These results may be extrapolated to suggest the importance of representation to inspire people with a myriad of goals, not just young inventors.

 

The income gap in innovation likely has a number of explanations. The first major explanation that I can think of is risk. The ability to take on risk is a high-income privilege; if a person always knows they will have the money to eat and pay rent, they can dedicate time and money to an endeavor that might fail

 

The second major issue is access. Children who grew up in high-income families have significantly more educational opportunities. They also are more likely to have familiarity with systems of capital or a support network to help manage those systems. They are more likely to have seed money and a much more ready ability to source a “friends and family” investment round.

 

Chetty and his colleagues call these children “Lost Einsteins.”

 

 

The funds that have helped me develop this project are through the Davidson Innovation and Entrepreneurship program, which is just one more example of how privilege can afford innovation. Just think about how many people are smart enough to be sitting where I am right now. On my bed, in my campus apartment, working on a project that I’m passionate about, running late because I want to finish this thought. We’re losing out. Big time.

 

 

 

The UBI is a controversial “new” idea in economics that is considered both a way to encourage invention and protect from it. Though the UBI has been in the news lately as business leaders in Silicon Valley are championing the policy in the hopes of easing the transition for those technology will put out of work, the concept is not new. The idea, favored by the likes of Thomas Paine (whose Common Sense is now perhaps best known as what Angelica Schuyler has been reading), Martin Luther King Jr, and Chicago school economist Milton Friedman (best known for the monetarist theory) is not new.

 

And, of course, the controversy is not new either. As with any government payout, the UBI causes concerns about the “free-rider problem,” i.e. people who could be working do not because they are content to live off of government handouts. That said, I’m inclined to think that we would not see a pandemic of non-working Americans. First of all, capitalism is driven by individuals striving to attain a certain level of luxury. Many people in this country work crazy hours and have little time for leisure because they have to in order to survive. But many people also work crazy hours with little or no time for leisure because they want the money that comes with it (I don’t think anyone goes into investment banking for that great work-life balance it provides). People will still work hard. People will still have passions to pursue and luxuries to strive for and, honestly, you can only watch so much Netflix before you need to do something else.

 

Shyam believes, similarly, that we won’t see a huge drop in labor force participation because of simple, evolutionary human nature. People are naturally competitive and we naturally (for better or for worse) tend to measure our success by the success of others, be it in terms of wealth, achievement, or personal life successes. That nature cannot be overwhelmed in one fell swoop.

 

University of Chicago Economist Iona Marinescu compiled data on a number of UBI-like programs to compare the results and extrapolate to the impacts of potential future policy options. The closest program to a full UBI is the Alaska permanent fund, which pays out small dividends of about $3000 to all citizens of Alaska. Her data shows no shift in overall labor force participation save a small shift from full time to part time workers. She says that while the results may be different with a larger transfer, say, at the poverty level, the increased aggregate demand would drive a larger increase in labor demand that would counteract those effects.

 

The unique particularities of the UBI offer a lot of technical advantages:

 

Universality and Unconditionality

One of the reasons that we don’t have more empirical information to predict the effects of the UBI is that most programs affect only a specific portion of the population that meets a given condition. Conditional programs are susceptible to a lot of inefficiencies:

  1. Poverty Traps

Critics of current welfare programs, according to Marinescu, say they contribute to poverty traps. If we condition cash transfers or program eligibility on a certain level of income, then making 1 extra dollar can move a person over the eligibility threshold and cost them severely. Thus, marginal tax rates are actually the highest on the very poor, where a very small change in income can cost a lot. For those individuals, every time they get close to surfacing from poverty, the rug is pulled out from under them.

  1. Ineffectual

Often unemployment benefits are given a set time limit, the idea being theoretically to make sure that people do not take advantage of the policy. However, sometimes, there are simply no jobs to be found, and then these policies fail to protect those who really need them. Many attempts at foreign aid are also not having the intended impact. According to a New York Times Magazine article, recent studies have shown that programs like PlayPump are not effective in increasing access to clean water, while microfinance and skills training are expensive with little affect on stability or poverty.

  1. Inefficient

Many programs that are conditional lead to inefficiencies because they force people to make choices they otherwise might not have, such as taking a job that is not right for them or spending a certain way. Even if a program is effective, is it the best way to be helping people? The same NYT Article sites an executive of a relatively young nonprofit, GiveDirectly, asking ““Could you imagine sitting in an office in London or New York trying to figure out what this village needs?” An active participant in the ongoing debate about the efficient use of money, GiveDirectly has been exploring the UBI as a better alternative to many foreign aid endeavors. The article, titled(I think rather inappropriately, as it offers little evidence of shrinking labor supply) “The Future of Not Working,” follows the GiveDirectly executives through Kenya as they roll out their plan in pilot villages to measure its effects. Anecdotal evidence suggests that the program would be effective: many of the recipients’ spending decisions are entrepreneurial in nature, or they are spending on basic needs such as food, better roofs, or even paying down a dowry. Lowrey also notes that many proponents of the UBI think that it could have the most impact in the poorest regions.

 

Labor Force

I believe that the UBI will affect labor supply, but I don’t believe that the UBI would shrink the labor supply. Instead, the program would make the labor supply much more elastic, and which could be huge for workers. For those of you unfamiliar with the concept of elasticity, the quick and dirty explanation is how responsive you are to a change in price. You can literally think of price elasticity like ratty sweatpants versus skinny jeans. Ratty sweatpants have an elastic waistband (see what I did there), so if you gain some weight the sweat pants will move in response. When something is price elastic, the demand moves in response to a change in price. Your skinny jeans on the other hand, are not budging if you gain weight. I think you see where the metaphor is going. Goods traditionally considered relatively inelastic are things like medication, food and water, and other necessities. That should make sense if you think about it: if the water company raises the price of providing running water to your home, you’ll probably still pay for it unless you truly can’t afford it. Relatively more elastic goods are things that people can live without, both in the literal basic need sense, but also in the more colloquial “okay, I can live without splurging on this” sense. Whatever your typical non-necessity spending is—clothes, eating out, video games, Netflix, extra lives on candy crush—if the price goes up, you might be more inclined to buy less of it. The concept applies to supply as well: some producers will lower supply a lot if the price drops, and some producers will not lower supply very much at all. One reason for that is the cost structure: if producing a good has a lot of variable costs (i.e. costs that are incurred with each unit of production, such as source materials or hiring an additional hour of work) a good will be more responsive to price changes. If a good has a lot of fixed costs (costs that are incurred no matter how many units are produced, i.e. factories and equipment) then the change in price will not cause a major shift in quantity supplied. Firms with high fixed costs need to get a certain amount of revenue to cover those fixed costs or they’ll have to go out of business.

 

In terms of labor supply, you can almost think of a worker as a firm with high fixed costs. Food, water, shelter, clothing, electricity, student debt perhaps. At a certain point, they have to sell a certain number of units of their labor to cover their fixed costs (i.e. survive). For that reason, labor supply is extremely inelastic, particularly at the lowest end of the income distribution, which means that firms have an inordinate amount of power over workers. Minimum wages and unions are two examples of strategies employed to protect workers, but minimum wage doesn’t really give workers bargaining power of their own and unions are controversial and do not protect everybody.

 

The UBI could give workers the ability to say “no” in a way they never have before. It allows for the possibility of a fair market solution as opposed to interventions to correct market failure. The impacts would be not just on wages but on a lot of other workers rights, such as legally mandated break times, paid sick leave, maternity leave, vacation, and exploitative policies such as split-shifts or on demand scheduling. I strongly believe that we are looking at a possibility to give a market absolutely riddled with market failures the chance to reach socially optimal conditions. (By the way, market failures are one of my very favorite topics in economics so BOLO for a post on that). Though it will almost definitely mean firms will have to pay higher wages, labor demand should increase as demand for goods and services is spurred upward by the stimulus of the UBI. Not only that, but the evidence of who benefits from economic growth is staggering: given workers bargaining power would ensure that increased profits from that increased demand is actually passed down to the worker instead of being absorbed by the company.

 

Innovation and Externalities

 

Among the most commonly cited benefits of the UBI is its capacity to encourage innovation and invention, either by assuaging fears of mass automation or by giving people a literal safety net to go out on a limb and try to start something new. Just as people will have the opportunity to say no to jobs that are not offering fair wages or conditions, people will also have the ability to leave secure sources of income in favor of entrepreneurial endeavors without the risk of losing everything. The UBI would very likely help correct the major income bias of the “Lost Einstein” phenomenon and encourage innovation and risk taking, which is very healthy for economic growth. The UBI would also encourage people to go into industries with high externalities whose wages do not match their value to society. For example, as romanticized as the “starving artist” trope is, the opportunity to pursue an artistic path is definitely not open to everyone. Huge sums of money, governmental and nongovernmental, go toward supporting the arts or artists in various ways, so we know that the production of art is something whose social value exceeds its market value as well. While the arts are the typical example of the underpaying career (unless, of course, you make it big), plenty of other careers provide benefit that significantly outweighs their compensation. Becoming a social worker, a public defenders, or a doctor in rural area requires an advanced (and expensive) degree and a buildup of debt and expenses that make these careers infeasible for many qualified people. Non-profit work is another example that many people would elect to do given the basic income to supplement the relatively low salary.

 

Drawbacks

So, clearly, I think the UBI has incredible potential. I really support, at the very least, continuing to explore the possibility. With any economic policy, even if one with a lot of theoretical capacity to do some good, you have to figure that it has an extraordinary capacity to destroy everything. We need to be skeptical always. The whole “trust, but verify” thing is never, ever a good, or even viable, idea in economics. Do not trust until you have tried really, really hard to verify, but also know that you probably will never totally be able to verify because you can’t control for everything that is happening in the world to isolate effects. I have spent a really long time trying to think through the issues posed by the UBI, and the following are a few I’ve come up with.

 

It’s not a fix-it-all

The UBI is essentially justified by the idea that people are the best judges of how allocate their resources (both money and time). I have just spent a lot of time enumerating the ways in which the UBI could help a free market function better, particularly in the labor market. But we will never ever exist in a world in which markets are single-handedly capable of reaching optimal solutions by almost any standard of optimality.

 

Many who are considering the UBI in a country like the US are viewing it as a replacement for all other forms of welfare policies and social safety nets. A GiveDirectly executive said, “if half-jokingly: If cash transfers flourished, ‘the whole aid industry would have to fire itself.’”

 

A recent IGM panel on the UBI asked a variety of economists to respond to the following statement: Granting every American citizen over 21-years old a universal basic income of $13,000 a year — financed by eliminating all transfer programs (including Social Security, Medicare, Medicaid, housing subsidies, household welfare payments, and farm and corporate subsidies) — would be a better policy than the status quo.

Only 2% agreed. With 19% uncertain, the other 79% of panelists disagreed or strongly disagreed. In other words, approximately the same proportion of dentists who recommend trident to their patients who chew gum don’t think the policy outlined above is a good idea. While some economists disagree on principle with the UBI, (“Bill Gates would get 13K, which is crazy”—Oliver Hart, Harvard; “Some people eligible for welfare choose to not apply, making this proposal unnecessary.” –Kenneth Judd, Stanford) the majority of those who chose to leave comments with their vote had concerns about the replacement aspect (or other specifics of the plan).

For instance:

 

“There is much to recommend a universal basic income, but specifically a 13k income while ending all other transfers is difficult to assess.” –Larry Samuelson, Yale (vote, uncertain)

“A properly designed negative income tax could be part of a better policy, but replacing everything is a bad idea.”—Richard Schmalenesee, MIT (vote, disagree)

 

“The simplicity is attractive, but deceptive. Coupled with universal health care & tax reform it could work. but we are far from that.” Christopher Udry, Yale (vote, disagree)

 

“Total health expenses and risk will remain high for individuals…” Marcus Brunnermeier, Princeton (vote, disagree)

 

 

Many also commented that $13,000 was not nearly enough to live on, or criticized the fact that it was only for persons above 21 years of age (and therefore not universal, and also causes problems for families living on the same income with several children). However, what the economists above pointed out is that specific, targeted government welfare intervention is still crucial. The healthcare market, for example, is one of the markets most susceptible to failures and inefficiencies, and trying to treat the UBI as a magical replacement for everything else would definitely be a mistake.

 

Similarly, in the context of GiveDirectly and foreign aid, we need to particularly bear in mind limits of infrastructure, technological capacity, and governmental systems of developing countries. For countries without a strongly developed insurance industry, or with large populations that cannot access that system, targeted medical aid, such as the delivery of medication or the services of medical professionals make a huge difference. Many of the aid organizations also target specific demographics: for example, some are specifically focused on empowering women in different regions. The danger with the UBI is thinking that it can erase all the other shortcomings of a free market economy. And since we can’t use it as a replacement for current spending, at least not entirely, then how do we finance the program?

 

Lack of Empirical Data

Although Marinescu’s report does cover a lot of ground and show early promise, none of the currently running experiments constitute a full UBI. The closest, the Alaska Permanent fund, is a transfer of $3,000; I don’t think we can reasonably extrapolate labor market effects from a transfer of $3,000 to a transfer at a living income. If anything, the shift from full time to part-time work is disconcerting because it suggests that given the income, people will work less, but the amount is not high enough for them to leave work altogether. Meanwhile, the Roosevelt Institute found in a study that a $1000 a month UBI would increase GDP Growth by 12.56% over 8 years if financed by government debt and 2.62% if financed by increased redistributive taxes. They also say that the UBI would ultimately decrease federal deficit. Once again, you can find the full report here, or summary information here. First and foremost, I never believe growth projections. Unless you’re Raven Baxter, Alice Cullen, or Sybil Trelawney, I don’t want to hear it, and honestly I’m pretty sure macroeconomic indicators for the better part of a decade are outside their psychic scope anyway. I know that growth projections are used in a lot of important decisions in a wide variety of fields, but frankly I’m not sold. I’m also healthily skeptical of any program that aggressively increases government spending and promises to reduce the deficit. Don’t get me wrong, the theory to back it up exists: the resulting stimulus leads to government revenue that outweighs the increase in expenditures. My problem is that the UBI requires continuous payments and many of the stimulating results will not kick in right away. Supply cannot always respond as fast as demand can change, the presumed innovation effect will need time to take root and flourish, and the transition period in the labor market might cause a small hiccup in productive capacity. None of these mean the UBI doesn’t make sense and that the economy won’t get beyond these bumps in the road, but they do require us to be skeptical about promises made by supporters of the policy. All I can say is this: without a whole lot more data, if they do instate a UBI I can promise you nothing except the money they decide to give out and that I will be watching the drama on capital hill unfold with a giant bowl of popcorn.

 

How Much To Give

The Alaska Permanent Fund is $3,000 annually. The amount suggested by the Roosevelt Institute is $12,000 annually. The amount suggested in the IGM question is $13,000 annually. None of these amounts represent a living wage. I am not confident that transfers in these amounts will have the same positive effects outlined above: workers may not have as much bargaining power if they can’t make a living without work, and innovators won’t take risks if their safety net is not strong enough to catch them. Of course, a policy that tries to approximate a living wage will be significantly more expensive and poses more risk of a shrinking labor force. We also need to consider wildly fluctuating costs of living and whether we can find a “one size fits all” optimal income.

 

Inflation

Theoretically, aggregate supply should move to meet aggregate demand, which should keep prices relatively stable as the UBI goes into effect. I absolutely believe that overall aggregate supply (or total productive capacity of the economy) will increase which would push price levels down, but I worry that supply can’t change as fast as demand and we will see, at least in the short run, a fair amount of upward pressure on prices (although one way to mitigate this would be to create a significant lead time between the passing of the UBI and the release of payments, which would give producers time to gear up). Regardless of the impact of the policy itself on prices, inflation will come. If the UBI is given at a discrete, nominal value, be it $3,000, $13,000 or $30,000, then we might run into the same problem we are having with minimum wage: the wage level was set 11 years ago and is constantly a source of political debate. If the UBI amount is not responsive to inflation, we will very likely start to see the positive effects of a universal income (increase in consumer demand, increase in innovation, increase in optimal working situations) decline.

 

No Going Back

 

If you think raising taxes is unpopular for a politician, try finding one excited to tell everyone that they will be actively taking away a significant, steady source of income. If we put a UBI into affect, odds are we are going to have a very hard time getting rid of it. Basically, we’d better be sure it’s really going to work.

 

 

 

 

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