An Economist Walks Into a Brothel: And Other Unexpected Places to Understand Risk

by Allison Schrager

To find out which Americans face the greatest systematic income risk, economists measured trends in American earnings when the economy was up or down since the 1950s using Social Security records. They noticed a U-shaped pattern with income and systematic risk, which indicates that systematic risk is more severe for both very low-paid and very high-paid workers, while people in the middle face less risk. It is not surprising that the lowest earners are also the most vulnerable when the economy falters. They work in industries with high betas, like retail, that tend to crash when the economy goes south. As a general rule, the more you earn, the safer you are. But there is an exception: when it comes to the highest earners, the relationship changes. For example, people who work in finance make ridiculous amounts of money, but they also often expect to lose their jobs when the economy sours (the more systematic risk you take on, the bigger your expected gains). Of course, few people feel sorry for them. Their income is so high, they can survive a layoff better than minimum-wage employees who live paycheck to paycheck and also risk being laid off in a downturn. But at least some of the high pay in the finance industry is compensation for the fact that the income of its workers is more sensitive to economic conditions.