Risk-taking, skill diversity, and the quality of human capital: how insurance affects innovation

We argue that human capital does a better job of fostering innovation when an economy has a diverse portfolio of specialist skills to draw on. While such a diverse portfolio is beneficial for a country, it includes many individual skill packages that are subject to considerable labour market risk. In the absence of strong income insurance (job security or unemployment insurance), the flight to safety in human capital investments will produce a national skill portfolio which is poorly diversified and less conducive to innovation. Using country-level data for 25 OECD countries from 1985 to 2009, we find evidence that income insurance raises the marginal effect of human capital on innovation, with the latter measured by patenting. At the same time, we find a direct negative effect of insurance on patenting; at low-medium levels of human capital, the direct negative effect more than offsets the positive indirect effect, while at high levels of human capital the indirect positive effect dominates. We draw implications for income insurance and education policy.