The Insurance

Begin with a single, under-noticed asymmetry between the two ways a business pays out. The wage is a fixed sum: agreed in advance, owed in full, indifferent to how the venture turns out. The worker promised a hundred pounds a week is owed that hundred whether the firm triples its sales or loses half of them; his claim does not swell in the boom or shrink in the slump; and it is senior — the law and the queue alike put it ahead of the owners’, so that wages are paid before profits, in good times and in the bankruptcy court the same. Profit is the mirror-image. It is not a fixed sum but a residual — what is left over, if anything, once the wages and the rent and the suppliers and the interest have all been met. Frank Knight, who thought about this harder than anyone, put it exactly: profit is the residual, what remains after every contract has settled, and the one who takes it bears the brunt of all that no one foresaw.¹1Frank Knight, Risk, Uncertainty and Profit (1921). Knight separated risk (odds that can be measured, and so insured) from true uncertainty (which cannot), and argued that profit is the reward for bearing the latter: the residual left once the fixed, contractual claims — wages foremost — are paid. When the firm does well the residual swells and the owner grows rich; when it does badly the residual thins to nothing; and when the firm loses money the residual turns negative — the owner does not merely fail to gain but actually loses, while the wage is still paid out in full.

Hold those two shapes in mind, for they are the whole of this plate: a claim that is flat — the same in every weather — and a claim that is the gap between the firm’s fortune and that flat line, and so takes every rise and every fall. The worker holds the first. The owner holds the second. Everything that follows is a consequence of which claim is whose.

Set the two claims side by side and what they describe is an insurance policy. The worker, holding the fixed claim, has been insulated from the firm’s fortunes: his income does not shake when the firm’s does. The owner, holding the residual, has absorbed all the shaking — the variation that might have fallen on wages gathered, instead, onto profit. This is not a metaphor but a mechanism, and the economists who formalised it, Martin Baily and Costas Azariadis in the 1970s, said so outright: a firm is, among other things, an insurer — a party able to bear risk, shielding its more risk-averse workers from the shocks of the market by promising a steady wage and taking the fluctuations onto itself.²2The ‘implicit contract’ theory of Baily (1974) and Azariadis (1975): a risk-neutral firm insures risk-averse workers against shocks by paying a steady wage and absorbing the variation, in exchange for a lower average wage — the premium. Workers at firms that insure them best are found to accept pay a few per cent lower for the security. Knight had seen it half a century before, and called it the heart of the entire system: the bold, he wrote, ‘assume the risk and insure the doubtful and timid’ by guaranteeing them a settled income in return for the uncertain remainder — and that, he said, simply is the enterprise and wage system of industry. And, like any insurance, it is not free. The worker pays a premium — not as a separate fee, but folded into a lower wage: the steady hundred he accepts is, on average, somewhat less than the swinging sum his work would fetch if he shouldered its risk himself, and that discount, the price of safety, is what he pays the owner for carrying the risk in his stead.

You sold the gamble, and kept the floor.

This bargain answers a question the earlier plates left standing. We have seen why a person must take some wage — the alternatives were closed — and what they submit to in taking it: direction, the order, command. But neither tells us why so few of us strike out as owners of our own enterprises, claiming the residual instead of the wage; why the world is so overwhelmingly made of employees. The answer is risk. Most people are risk-averse: offered a certain fifty thousand, or a venture worth fifty-five in expectation but with a real chance of nothing, they take the fifty thousand — and are right, by their own lights, to do it. The wage is the institutional shape of that preference. It sorts us.³3Kihlstrom and Laffont (1979) modelled exactly this sorting: those least averse to risk become entrepreneurs, taking the uncertain residual; those more averse become employees, taking the certain wage. The wage and the firm are, on this view, the institutions a risk-averse population builds to shed risk onto the few willing to hold it. Those most willing to bear uncertainty become the entrepreneurs and the owners, and claim the residual with its risk; those who would rather not become the wage-earners, ceding the residual for a sum they can count on. To take a wage is, in part, to have declined a gamble — to have chosen the certain floor over the uncertain everything, and to have paid for the choice with the upside it forecloses. It is the prudent course, and the common one. But it is a choice, and it has a price.

Seen from one side, this is among the kindlier arrangements in economic life, and its defenders are not wrong to insist on it. The worker is genuinely protected. The firm may have a ruinous year — a failed product, a market that evaporates — and the worker, unlike the owner, is spared the ruin: his wage is paid, his household holds steady, the blow falls elsewhere. He has been shielded from the very thing that breaks the entrepreneur, the lurch and plunge of an income lashed to fortune; and the profit the owner draws in the fat years is, on this reading, no theft but a fair return for having carried, the whole time, a burden the worker was relieved to set down. Nor is it a swindle in which one side’s gain is the other’s loss: the worker, by his own preference, is better off with the steady wage than with the gamble, and the firm is better off bearing a risk it is large and diversified enough to absorb — both are improved against a world in which the bargain did not exist.⁴4In the implicit-contract models both parties gain relative to a bare spot market for labour: the worker buys a smoother income, the firm earns a higher average profit for supplying the insurance. On this account the wage bargain is a mutual improvement, not a zero-sum extraction. No one chose the safety with eyes shut. The premium buys something real and dear — a life that can be planned — and most of us, most of the time, are glad to pay it.

Seen from the other side, the identical structure is the quiet engine of the divide between labour and capital — and its critics are not wrong either. For if the wage is fixed and the profit residual, then every gain beyond the agreed wage, however vast, flows to the owners and none to the workers who helped make it. When an enterprise does not merely survive but soars — when a firm comes to be worth a hundred times what was put in — the workers who built it draw the same fixed wage they were promised, while the residual, now enormous, falls entirely to capital. Marx gave this reading its hardest edge: the residual, to him, was surplus — value made by labour and taken by the owner under the cover of a fair wage.⁵5For Marx the residual was surplus value, created by labour and appropriated by capital. One need not adopt his framework to note the asymmetry of risk: a shareholder diversifies across many firms and bears only what cannot be diversified away, while a worker cannot diversify a single job and the human capital sunk in it — so labour often carries the more concentrated risk, yet capital takes the residual. One need not follow him the whole way to feel the asymmetry, which is sharpened by a fact the insurance story tends to pass over: that the owner’s risk is often far smaller than it looks. A shareholder spreads his stake across many firms, so that any single failure costs him little; he bears only the risk that cannot be diversified away. The worker cannot diversify. He has one job, one employer, one stream of income, and his human capital — the years and the skill he has sunk into this work — is staked, undivided, on this one firm. It is not at all clear that the party bearing the larger and more concentrated risk is the one who draws the residual; often it is the reverse. And the insurance, besides, is imperfect: when the bad year comes the firm may simply break its unwritten promise and lay the worker off — so that the cover lapses precisely when it is most needed, and the worker proves to have borne the gravest risk of all, the loss of the whole income, after everything.

All the gain falls on one side of the line.

In truth the fixed wage and the residual are not two boxes but the two ends of one line, and a working life may sit anywhere along it. Every device that hands the worker a piece of the residual — a bonus tied to profit, a commission, a grant of shares, a partnership, the membership of a cooperative — slides him toward the owner’s end, trading a little of his safety for a little of the upside; and done well, the share of fortune is added on top of the steady wage, so that the worker keeps his floor and gains a window on the gain.⁶6Profit-sharing, stock grants, employee-ownership plans, and worker cooperatives give workers a share of the residual — moving them toward ownership. The gain is greatest, and the danger least, when the residual share is added atop a secure wage rather than substituted for it; staking one’s whole livelihood on a single firm concentrates risk severely. But the line runs the other way too. The gig contract that pays only by the task and guarantees nothing has stripped the wage of its insurance — handed the worker back all the variation a wage was built to absorb — without giving him, in return, any share of the residual his platform earns: the risk of the owner with the claim of the labourer, the worst of both ends. Where a worker sits on this line — how much of his income is the safe, fixed, capped thing, and how much the risky, residual, unbounded thing — is among the most consequential facts about his working life, and among the quietest. Most people, asked, would not be sure where they stand.

So this single price, which we have watched measure the worth of all things, sell the hours of a life, stand as a pledge and fall under compulsion, settle by power and bound the day’s work, refuse from dignity to drop, and buy the obedience that makes a firm — does one thing more, beneath all of those. It shelters. It is the roof the worker takes in exchange for the harvest: he gives up his claim on the bumper year, and in return the failed year cannot ruin him. The wage is the storm-insurance of a life, and its premium is the fortune one agrees never to have.