Are employees compensated for the risk of unemployment?
The job market risk and return
In order to answer the question “are employees compensated for the risk of unemployment” I collected, filtered and compared data for 456 different jobs in the U.S taken from the Bureau of Labor Statistics for 2012–2013. I then plotted the professions’ risk of unemployment against their expected yearly wage. The expected yearly wage of a job is its average salary across numerous individuals in different career stages. For the risk of unemployment, I used unemployment rates data as it reflects the chance of not finding a job for a specific profession at any career stage. Different colors in the graph separate the data by industry. While one might expect that as with any investment, taking higher risk will result in higher returns, it appears that our data on the job market shows the exact opposite.
This work was inspired by the Security Market Line (SML) that shows the different levels of risk of securities plotted against their expected returns. Unlike the Security Market Line, the risk of unemployment represents both specific and market risk. It is affected both by specific events as well as market conditions. The notion of mitigating risk by diversification comes less into play with jobs since, unlike securities, a single individual can only be qualified or work in a handful of jobs. It is also harder to create a portfolio out of jobs.
Efficient and inefficient professions
By comparing the different professions’ risk and returns, we can see that some professions offer the same returns as other professions but with a lower risk. Judging by those characteristics only it is clear that the first are preferred. These professions are called “efficient” and any profession in our graph is more efficient than all the professions to its right and to its bottom. If we draw a line that connects all the efficient professions (our efficiency frontier), we’ll get a plot for the optimal level of return we can get for any level of risk taken. However, unlike with securities, this line only includes a handful of jobs!
What our data shows
One might expect the graph to have more of a right tail distribution. After all, we would expect taking higher risk would have an incentive in the form of returns. It is clear that risk and return are not the only parameters for an individual when choosing a profession. It is also clear that not every individual can be qualified to work in any profession. However, even within the same industry, such as the construction industry and within professions that require similar training and resemble in skill set — we still see many inefficient professions.
Implications
We can expect that over time, inefficient professions to become less popular and efficient professions with a similar length of training requirements and similar skill set to become more popular. If we’ll assume demand for these professions to remain similar, the lower supply will assure us these professions will become less risky. Professional schools should aim to optimize their training for both risk and return to balance the above.
Another implication can be the view of a family as a micro portfolio. It would be smart to offset high risk-high return professions such as acting or professional sport with moderate risk-moderate return professions like nursing or teaching.
An interactive version of the job market risk and return graph can be found here: https://bit.ly/jobmarketriskandreturn
