An Insurance-based model of compensatory wage determination

Abstract

This paper aims to provide an account of the theory of compensating wage differentials that does not factor in the worker's marginal productivity or measure her loss in terms of net disutility. It is argued that the Worker's claim to a productivity wage is undermined by the pervasive influence of luck. In addition a utility-based metric is rejected on the grounds that it reflects the existing inequality in the distribution of resources. We propose instead that compensatory wage differentials should be fair in the sense that they are envy-free. That is, no one prefers their combination of working conditions and compensatory wage to anyone else's. In order to characterize the envy-free compensatory wage we employ a hypothetical insurance market where each insuree is unaware of the job she will end up in.