Why is it riskier to be a worker than a capitalist?

We take it for granted that capitalists hire workers rather than workers hiring capital, but why? The main reason is the difficulty of diversifying labour, which means that workers ideally require some form of insurance to offset their concentration of risk. But that is only imperfectly available through the market and this is an important justification for the role of the state, quite separate from any argument for redistribution.


The sad collapse of the parcel delivery company City Link, announced very unfortunately on Christmas Day, has led to understandable anger and frustration, mainly because some 2,350 jobs have been lost. The owner of the company was a private equity firm called Better Capital, run by a prominent investor called Jon Moulton. I’m not aware of Mr Moulton having done anything wrong but he is something of a hate figure for those who dislike private equity in general, mainly because he is courageous (or foolish) enough to talk about these things in public, and defend the role of capitalists. He has been highly critical of other parts of the private equity industry, accusing many of his competitors of charging too high fees and abusing the tax treatment of private equity.

Companies go bust all the time and in each case there are losses to owners and employees.  In the City Link case, the company is being liquidated, which means that its remaining assets such as vans, computers, warehouses and so on, will be sold to new owners. As is common in business, the company leased many of its assets, so it doesn’t own that much (a lease is a long term agreement to use an asset owned by somebody else, in return for a fee, rather like renting it). But there is enough to limit the losses of the private equity fund, which made its investment mainly in the form of secured debt. That meant it was first in the queue for any cash available from selling the assets, ahead of redundant employees who are merely unsecured creditors, who will get what’s left, if anything, after the secured debt is repaid. Better Capital’s remaining investment, in the form of equity, is last in the queue and will be completely lost.

Many writers have commented on the seeming unfairness of this perfectly legal arrangement. Chris Dillow, who writes for Investors Chronicle and has an excellent blog called Stumbling and Mumbling (which in no way does it justice) asks a more profound question about the asymmetry of the damage done by the company’s collapse. Why is it so unequal? One owner (Moulton) loses a small fraction of his wealth. Thousands of employees lose their entire income and may be unemployed for some time. Some of them actually spent their own money on vans, including the costs of the City Link paint job, which is worth less than nothing (you have to pay to have it removed to make the van saleable to somebody else). Jon Moulton has reportedly lost a few million pounds, which is not trivial, but he is also reported to have £170m. (I don’t know if these figures are accurate.) So the “risk-bearer”, the capitalist, is actually well insulated from the damage. The worker, who we normally think of as benefiting from the risk-bearing of the capitalist, actually has a much greater exposure to the risk of the company failure.

Let’s consider further the difference between the capitalist and the worker. In most companies, the capitalist puts in finance and hires the other resources needed, including workers. But capital can be diversified. Somebody with say £100m can put it into say 20 different companies. Assuming good judgement and a wide mix of sectors, the risk that more than say 10% goes wrong in a single year is quite small, so an expected return of say 11% provides a return greater than expected losses. A worker cannot diversify his or her labour so easily. Working, as opposed to owning, is not something that can be done efficiently for several different companies.

The difficulty of diversifying labour income

Why is this? The only two groups of people who routinely have more than one job are low income people and the well off. Low income people often work in two or even three jobs because the pay of each is so bad that they must work more hours in total to earn enough to feed their families. Low pay acts as a terrible trap for many people, who can never find the time to invest in training or even to search for better jobs. This is economically inefficient because they can’t improve their productivity, as well as being unjust.

At the other extreme, some high income people are able to do multiple jobs of a very different type, such as non-executive directorships which require a limited time commitment. Often these are done by semi-retired people who have experience and credentials (which are essential to being a good director) but also have earned enough money in the past to not need a full time income anymore.

But everyone else has a single job. Anyone who has, like me, tried a “portfolio career”, in which you do three or four different activities, with perhaps one being a charity or pro bono work, tends to find that it’s rather stressful and unsatisfying. Four one fifth time jobs don’t in practice leave you with a day a week free. And you can end up feeling that you’ve done four things not very well rather than one job really well.

That’s because any activity, even being a governor of a sixth form college (as I used to be) takes a minimum amount of time and effort to do properly. In any normal job there is a fixed cost of turning up to work, learning about the business, getting to know the people and keeping abreast of the news. Once you’ve done all of that you can become productive. So there is an incentive to minimise the amount of fixed costs by having only one job. In economic terms this means there are increasing returns to work – you tend to be more productive and therefore better paid (and probably more satisfied) by applying yourself to a single job fully than two jobs on a half-time basis. (This is similar to the economic reason why you typically have a single electricity cable coming into your house. It is not efficient for another company to try to compete by adding a second one, because of the high fixed costs of digging up the road.)

There are of course some compensations in the other direction, mainly the enjoyment of variety in having multiple roles in contrasting organisations, and outside interests can yield networking benefits. But I think it’s fair to say that most people who are employed, including self employed, who are not on low pay, tend to have a single job.

But that means they face a high concentration of risk. If their employer collapses for some reason (individual corporate mistakes, technological change, macroeconomic recession, sheer bad luck) they lose their entire labour income. Most people have no alternative income (such as income from capital) so the cost of losing their job is high. (We have plenty of research on the psychological costs of unemployment also, beyond just the damage to one’s standard of living). This is one reason by it is bad economics to invest in the shares of the company you work for (unless there is a tax break or some other inducement). You are just further concentrating your risk exposure.

So a group of workers with a good business idea are unable to hire the financing for a company in which they “invest” their entire labour income as easily as a capitalist can put funds into a business that is just one of many he or she invests in.

How to insure against the risk of losing your job?

Now, to an economist, a problem of diversification or over-concentration of risk immediately suggests a market solution – insurance. For any one person to insure their house on their own is unaffordable, leaving that person worried about the unacceptable risk of their house burning down or being flooded. But there is a collective solution to that problem which works well – an insurance company can charge insurance premia to many such persons, taking advantage of its ability to diversify the risk. If, in any one year, the risk of fire is reasonably predictable on average, the company can calculate a profitable amount to charge that will cover the cost of compensation and leave a profit. Fire insurance then becomes affordable and the worry of your house burning down is removed or at least markedly reduced. (Flood insurance is less easily diversifiable, as it is obviously somewhat geographically concentrated, so we see a lot of state intervention in flood insurance. Climate change may make private insurance of flooding unprofitable as the correlation risk increases.)

But can you insure against losing your job? There are some very limited private insurance schemes that will cover some of your outgoings, such as mortgage payments, in the event you lose your job. But these are very expensive and in some cases have been discredited as useless. The reality is that a private insurance market against unemployment has never existed and never will because of market failures. In particular, many job losses are correlated (that’s what a recession is) so the necessary basis for insurance – uncorrelated risks – doesn’t apply.

Which is why, in all rich countries, the state provides some degree of insurance through the tax and benefit system. Only the state can do this because it can take the non-diversifiability risk, by forcing everyone to contribute (which also removes the moral hazard and adverse selection risks, discussed here). More generally, the state can provide insurance to people for a range of risks that the private market fails to offer such as, the risk of being born disabled, the risk of a catastrophic accident that stops you working and the risk of being hit by natural disasters, the cost of which exceeds the capability of the private insurers. It also provides intra-life financial transfers in the form of pensions, in part because the private pension market works rather poorly and leaves too much risk with the individual. Ideally many people would like to take out a contract through their working lives that guarantees a future standard of living, relative to their current one. No such contract exists, you can only save, hope your investments do well and then see what the accumulated amount will buy. This is a very imperfect financial product but the state can, through intergenerational financial flows, can provide some degree of future income guarantee.

Many of those who criticise the state benefit system as “welfare” miss this point, or prefer to ignore it because their hostility to the state is ideological. Anyone is entitled to that view but they should accept that the roots of state insurance against ill health, unemployment and poverty in retirement are the failure of the private market to provide services which ordinary workers quite reasonably want. It is just an economic fact of life that capital can be more easily diversified than labour.

5 Responses

  1. Xueping

    Thank you for writing this article and sharing your thoughts. I am a law practitioner. Law practise to some extent is about identify risk and prevent risk as risk is something that can not be avoided but be predicted in terms of law practise.

    It is good to have another view of dealing with risks which is diversifying it which I think is more discussed in the economic term. And certainly could be borrowed when we provide legal advises to clients.

    As to labor, it is about trading time which is universally irreversible and sometimes along with health, happiness etc for money and skills or working experiences. Capital I assume you talk about something that could be calculated by money. In this context, money certainly is a way of expressing value and value could be talked about in a range which could be as high as it could be or as low as it could be. Therefore, in essence make your time valuable is the solution. Of course we could apply the economic way of thinking to diversify the risks e.g put money in different baskets etc.

    Just my quick thoughts after reading your article. Thank you for sharing.


  2. Marie Taylor

    Brilliant Article.I enjoyed the range of issues you cover and the linkages you make between markets and private equity and government. I particularly liked the comment about “welfare” and “benefit”. I’m all for renaming that state Insurance. Thank you for a thought provoking article.

  3. Abdulai Nyei

    Excellent Article and I` m pretty sure critics would rather uphold government efforts in stabilizing warefares.

  4. Estate Agents in Peterborough

    Very thought provoking article. I would agree with Marie on the whole renaming of “welfare” to “state Insurance. Namely as the common perception of “welfare” is pretty warped from what it once stood for.

  5. connect2hcb

    The thoughts captured in this post are so very true. For a worker it is important to appreciate and understand these thoughts and perhaps the most important of them all – the near complete dependence of a worker on a capitalist is a huge risk. As Robert Kiyosaki of Rich Dad fame said it so well, a worker needs to work for money whereas a capitalist has money working for her. Also given that life-time employment is long dead and the danger of recession is not going away any time soon, it would be wise for a worker to make sure the money she earns is directed towards achieving financial freedom from work in the shortest possible time. Until that point in time, a worker has to be paranoid about financial freedom. Remember what Andy Grove said “Only the Paranoid Survive”.

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