In response to the COVID-19 pandemic, the C.A.R.E.S. Act stimulus package passed in April by Congress represents a large income substitution intended to prevent the sudden rise in unemployment becoming a more severe depression. While intended to be temporary, the direct payments and unemployment insurance enhancements that U.S. families have been receiving, resemble aspects of Universal Basic Income (UBI). Given the success of the CARES act (up to this point) in bolstering consumption and savings through large fiscal transfers, there is a distinct possibility that legislators may look to make UBI (or some variant of it) a more permanent aspect of the United States’ social safety net.
Universal Basic Income (UBI) is a theoretical policy framework with the objective to provide U.S. citizens with a minimum level of public assistance. There are a variety of flavors of this basic idea, which attempts to balance the appropriate level of public support against the proper incentives to work. While it is distinct from minimum wage mandates in a variety of ways, the general tenets of minimum wages include familiar elements of UBI. At its most basic level, UBI offers to pay every U.S citizen (or subset of the population) an annual stipend. The idea has been gaining prominence in policy circles for the past few years. More recently, it was explicitly part of at least one of the Democratic Presidential Candidates’ election platforms (Andrew Yang). Similarly, Democratic Presidential nominee Joe Biden proposes lighter-touch aspects of UBI such as Short-Time work.
As the November presidential election nears, a concerted push by politicians to make UBI (or its variants) the law of the land represents an acute political risk to financial markets. A shift in policy preferences towards UBI would, at least thematically, represent a departure from the regime we’ve been operating in for the last handful of decades; a regime in which economic output in the U.S. was allocated more heavily to capital as opposed to labor (the later has been falling as a share of economic output for decades). A UBI regime would up-end this steady state and open up a number of risks that financial markets would have to consider.
Needless to say, a lot has to fall into place in order for this outcome to become a more readily apparent risk and subsequently tradeable market narrative. It is likely only possible in a scenario in which the Democrats hold the White House and both chambers of Congress. . Early indications are that the probability of a “Blue Wave” remains relatively low at 20-25% but even that is significantly higher than it was just 2 months ago.
History and recent appeal
UBI isn’t a new concept. For centuries, politicians and economists all over the world have been looking for ways for their citizens to participate in wealth creation. The concept of UBI and all its forms likely date back to the Age of Enlightenment in the 18th century. As most of Europe transitioned away from absolute monarchist rule toward democracy, the need for greater participation in prosperity demanded by the new voting majority required a rethink of wealth inequality.
The concept first surfaced in the U.S. with Thomas Paine and his call for a guaranteed minimum income through an inheritance tax (sound familiar?) in his pamphlet “Agrarian Justice” in 1797. 170 years later, Dr. Martin Luther King Jr. advocated for a guaranteed income to lift all Americans out of poverty in his final work, “Where Do We Go From Here: Chaos or Community?” But it isn’t just politicians and social activists who have advocated for such utopian ideals. Prominent economists from both ends of the political spectrum not only see value, but have openly advocated for it. Liberal economist and creator of the Beveridge Curve, William Beveridge headed up a committee in the 1940s to study the impact on the UK. While conservative economist Milton Friedman advocated for a negative income tax, which would serve as a supplement to a minimum (floored) income level.
However, through most of the 20th century, the biggest proponents of UBI were centered on consolidating the complex government welfare system. The concept of UBI was more theoretical with very few countries seriously considering it.
The turn of the century ushered in a new world order where globalization and technology drove a redistribution of income and wealth. More recently, prominent work by Thomas Piketty has highlighted the growing wealth divide amongst those who were able to capitalize on this shift away from labor toward capital. Andrew Yang has most recently melded the needs of people in an increasingly automated and digitized world into a new call for UBI. While his singular message during the Democratic Primaries was unable to attract large-scale support, his experiment with UBI and the public appeal they attracted, did propel the momentum of the progressive wing of the Democratic Party.
Rising inequality and a “winner take all” system which exists in some parts of the U.S. economy have brought UBI to the forefront as a policy solution. COVID-19 accelerated this process as the fiscal policy response (i.e. the CARES Act) is essentially a live prototype. The combination of USD 600/week unemployment insurance benefits and USD 1,200 per person in fiscal transfer serves as both UBI and a minimum guaranteed income to workers.
Process and Implications
At the end of 2019 when Andrew Yang dropped out of the presidential race, the prospects for UBI seemed remote. Six months later, the COVID-19 pandemic combined with social activism has not only reshaped the political landscape but increased the willingness of politicians to adopt more progressive views. The presumptive Democratic Presidential candidate Joe Biden has built a solid lead in key battleground states and Senate seats that have now shifted from red to purple make the possibility of a Democratic majority a reality. Moving the U.S. down this path would require Democrats to win the Presidency, maintain the House and win majority in the Senate. A “Blue Wave” in November is likely to see a roll back of the corporate tax cuts passed during the Trump administration as well as a roll back of the individual tax cuts, primarily for high income earners. This will provide the Democratic majority between USD 300 billion and USD 500 billion in “surplus” to allocate to increasingly popular progressive legislation. In fairness, Joe Biden hasn’t fully endorsed/adopted UBI in his platform, but if the unemployment rate remains over 10% at the end of the year, the recent stimulus package introduced by the House will serve as a template for future legislation. One could expect: extended unemployment insurance benefits of USD 600/week and additional “one-time” payments for individuals. With the scars of the COVID-19 virus expected to last for years to come, this “temporary stimulus” is likely to look permanent.
So, what does the macro backdrop look like if a “Blue Wave” carries UBI onto shore? Possible macroeconomic outcomes of more UBI-like fiscal initiatives include:
- Higher taxes
- Lower corporate profitability in the absence of pricing power
- Shifts in structural inflation trends
- Less dynamic labor markets
- Less labor force participation or incentive to work, lower productivity
- Lower inequality
- Lower poverty
Potential Market Impact
From a markets perspective, our intuition tells us that investors would perceive more UBI-like policies as negative for risk assets and conducive to higher long-term treasury yields driven by an increase in inflation risk premium. Most likely volatility would rise and the dollar would weaken.
Introducing UBI and implementing minimum income would certainly raise the cost of labor for businesses. Corporations would likely be forced to pass along the costs to consumers, although their ability to do so without damaging demand is uncertain. Despite the potential inflationary risks of this type of policy, with the economy and labor markets still adjusting to a COVID-19 world, we believe the Fed would focus on promoting growth over fighting inflation (given their confidence in controlling inflation down the road). Easy fiscal policy coupled with loose monetary policy and rising realized inflation should be bad for the currency value of all USD denominated assets. While generally, inflation expectations are positively correlated with growth and risk assets, this could be a unique scenario in which inflation expectations decouple from risk assets in anticipation of a potential stagflationary scenario as fears of corporate profitably outweigh higher incomes for consumers.
It is difficult to craft a story where equities do well in the face of higher taxes, higher labor costs and higher cost of funding. Real yields are likely to remain low as the productive growth of the U.S. is perceived to be impaired by less labor force participation, higher fiscal burdens, lower productivity (at least initially) and less dynamism in corporate America. Inflation Breakevens will widen and cost of funding to the entire economy is likely to rise. The scenario has all the hallmarks of a stagflationary environment albeit more tame than the 70s and 80s.
Similar to the 70s and 80s, the share of labor income should rise as a proportion of GDP at the expense of capital. The intended income redistribution outcomes of UBI towards the consumer will promote credit expansion to households and durable goods spending. We view these consequences of some of the limited bright spots for investors amongst asset classes.
The COVID-19 pandemic will evolve through the rest of 2020, its impact could reshape not just the potential outcomes of the U.S. elections but our society and the economy. The CARES act has provided a glimpse into how the U.S. would react to the tenets of UBI. Minimum guaranteed income through USD 600/week unemployment insurance benefits and fiscal transfers of USD 1,200 per person look like a shift toward an economic policy that was considered fringe or taboo for hundreds of years. However, when considering the CARES Act policy within the context of growing calls for wealth and income taxes, the winds of change advocated by Thomas Paine and the Age of Enlightenment may really be blowing in the 21st century. The first steps have been taken, whether intentional or not, and the impacts of this direction will have significant implications for workers, the economy and financial markets.
The potential outcomes that could occur on November 3rd are an underappreciated risk to markets. While a “Blue Wave” is still considered a tail-event, it is a risk that the market isn’t prepared nor positioned for and therefore could be quite disruptive. Watch the polling and the extent to which the Biden campaign makes UBI (or its variants) a more prominent part of its platform. If a “Blue Wave” were to occur in November, the U.S. is likely to see a roll back of the corporate tax cuts passed during the Trump administration as well as a roll back of the individual tax cuts, primarily for high income earners. Perhaps the most important question is: will the proceeds of tax cut rollbacks be used on infrastructure to improve the productive capacity of the U.S. economy or a more permanent revamp of how America does business and allocates capital?
J.P. Morgan Asset Management does not predict outcomes of any political events, nor do we voice firm-wide opinions on any political candidates