The Cantillon effect and UBI

Problem, meet solution

Imagine a group of children playing musical chairs. They scamper around the circle of seats while a tune fills the air. Some meander joyfully, while others are serious, constantly calculating an ideal strategy as they walk. When silence strikes, they squeal and rush madly for the chairs. The first to arrive slide into seats without resistance. As empty places become rarer, the cost of claiming a chair may include a struggle. Finally, a new equilibrium is established, and the game begins again.

This children’s game serves as a rough analogy for increases to the money supply, which, as I’ve discussed in previous posts, is a healthy part of a growing economy.

The Cantillon effect

The Cantillon effect refers to the different degrees of impact caused by uneven distribution of newly created money within an economy. The effect takes its name from the economist Richard Cantillon, who first observed it in the early 18th century. As newly injected money flows through the economy, prices may rise due to increased demand for goods and services. Like the game of musical chairs, the first to spend it make their purchases without competition; they get the cheap seats, so to speak. The last to do may face higher costs.

Cantillon discussed the phenomenon with the example of a newly discovered gold mine. In his time, hard currency served as the primary medium of exchange. By the 21st century, every nation has rejected the gold standard because of its inflexibility. Instead, we use a fiat currency, which can expand and contract in response to changing conditions. This money is primarily—about 95%—created by banks as loans.

The benefits of early access to new money, therefore, accrue to those who can borrow it into existence. This rewards financial institutions and large corporations who are best positioned to use it for investments and speculation, purchasing assets at lower prices before inflation takes hold.

On the other hand, individuals further down the economic ladder, who often lack access to credit, experience the negative consequences of the Cantillon effect. As the increased supply of money creates a new price equilibrium—inflation—their purchasing power declines. This disparity can exacerbate wealth inequality, which creates more societal problems.

Unconditional basic income as a solution

Unconditional basic income (UBI) is a system where the government provides every citizen with a reoccurring, no-strings-attached, cash transfer. Advocates generally want the amount of the cash to be enough for recipients to meet their basic needs, but any amount meets this definition. For example, since 1982 Alaska has distributed a UBI (averaging around $1,500 in recent years) to its residents, funded from oil sales.

The Cantillon effect occurs when some individuals or interests receive new money prior to other parts of society, giving them an advantage over others. The better, fairer way to handle new money is to distribute it as UBI. As I wrote back in March,

Whenever and however additional money is put into circulation, it must be wedged into the existing economy. That wedge lifts those above it upward, and forces those below it downward. Since the necessity to add to the money supply comes from the growth in our collective productive capacity, the natural and moral spot to place that wedge is at the very bottom of the economy, so that every citizen is lifted up and none are crushed.

Instead of new money predominantly benefiting the wealthy and well-connected, UBI ensures an equal share reaches every citizen. This more inclusive distribution mechanism offers many other benefits. Basic income trials around the world have found it improves the well-being of individuals, the economy, and society in general. It’s good policy, unlike allowing poverty to exist, which is expensive.

UBI: we could and we should

After I started looking at ways to address poverty five years ago, Andrew Yang’s presidential bid introduced me to the idea of unconditional basic income. It took a little research and reflection before I came around to understanding America actually could end poverty with UBI. The Cantillon effect explains why we should.