mining school can, through his knowledge of economic geology and metallurgy, make forecasts with some degree of certainty.

2. Safeguards of many kinds have been invented to reduce the risk of shipwreck, fire, explosion, burglary, etc. A modern ship is built in compartments as a safeguard against shipwreck; fire escapes are a safeguard against loss of life by fire; safety valves against explosions; and burglar alarms and safety deposit vaults against burglary.

3. Insurance consists in consolidating risks, i.e., in offsetting one risk by another by consolidating in one insurance company a large number of chances. Relative certainty is, as it were, manufactured out of uncertainty. Insurance, unlike increase of knowledge and safeguards, does not directly decrease the risk for society as a whole, but by pooling these risks it has the effect of steadying the income of individuals and spreading the burden of risk more evenly over all.

4. It seems at first to be a curious fact that speculation, although dealing in chances, may be used to reduce chance to some persons who use it for this purpose. We have already seen how short selling reduces the risk to the person sold to. A building contractor when taking a large contract was asked whether he was not taking a large risk, since he could not know in advance what the costs would be. He replied, "No. I am taking no risks at all except on 'labor'; I have made contracts to be supplied with material when needed at fixed prices." In other words, dealers had sold him future building materials "short." They had each assumed the risk of fluctuation in those special market conditions on stone, brick, timber, etc. Similar results follow from short sales of wool to the woolen manufacturer.

191. SOME FUNCTIONS AND EFFECTS OF INSURANCE1 Technical insurance is defined as that arrangement by which persons subject to a risk agree directly or indirectly with each other that those who escape the threatening event will make up to those who suffer by it the whole or a part of the loss.

The main purpose of technical insurance is to relieve the individual of the burden of risk resting upon him. Aside, however, from the direct effect of technical insurance, there are certain subsidiary effects upon the social organism. Some of these effects are good, and some are unfavorable. Let us consider the good effects: (a) The decrease

'Adapted by permission from John Haynes, "Risk as an Economic Factor," Quarterly Journal of Economics, IX (1894-95), 442-46.

of the cost of production. Under the head of producer's insurance we saw that risk to the individual producer was a subjective cost, and that marginal subjective estimates of risk enter in as a determinant of objective cost. Now, technical insurance comes in, and removes the major part of this item of cost. The producer, in place of carrying a risk that is burdensome to him, pays a premium which is relatively light. Nowhere is this more true than in the case of marine insurance. Imagine that marine insurance did not exist. The shipping business would be carried on only by great companies possessing many ships, so that they could get the benefit of self-insurance. It needs no argument to prove that the price of foreign merchandise would be much higher than now. Fire insurance is another excellent example of this fact. This brings us directly to the next advantage of technical insurance, which is a corollary of what has just been said. (b) It makes it possible for small producers to hold their own, where otherwise they would be forced out of business. (c) Technical insurance prevents the impairment of the productive force of society by putting productive agents back into their old positions after a disaster. President Walker shows how labor may become permanently degraded as the result of temporary misfortune. Suppose a village whose chief support is a single industrial establishment. Suppose this establishment burned, with no insurance. The employer cannot readily transfer himself to another place where his talents can be used so advantageously, and the same is true of the laborers. Both become discouraged, and the industrial efficiency of master and men may be forever impaired. Insurance guards against this calamity. Fire insurance, accident insurance, and insurance against sickness are efficient in the same way. Life insurance in a more direct way accomplishes the same result by keeping families together, and allowing the orphan children to be brought up with proper training, all of which results ultimately in increased productivity. (d) Technical insurance is an aid to credit. The practice is universal of requiring houses, or other inflammable property on which money is raised by mortgage, to be insured. Without insurance, many who now borrow freely from savings banks and other lenders would be unable to borrow at all, and others would borrow only at ruinous rates. (e) Life insurance combines what I have called self-insurance of the nature of saving with technical insurance. A form of life insurance which does not do this is conceivable, and has sometimes been tried; but the common form lays aside a reserve fund against the claim of each person insured.

This form of insurance, therefore, encourages capitalization. This, to be sure, is not a net gain, because a man who is insured, feeling a sense of security, is likely to spend that part of his income which is left after paying his insurance premium more freely than would be the case if he were not insured. But, as premiums are generally paid out of income, we may conclude with Schönberg that "there is generally a stronger building up of private capital than would otherwise follow." (f) The sociological and ethical effects which result from the security and comfort which insurance gives are influences for good.

The good effects above enumerated are not without some offsetting disadvantages. Security is good, but security as well as hazard may have an unfavorable effect upon industry. (a) Intensity of effort is diminished. Make the ordinary man's future secure even on a low material basis, and his energy will flag to some extent. (b) Carelessness is encouraged by insurance. Much wealth, for instance, goes up in smoke simply because vigilance is relaxed on account of the property being insured. (c) The greatest disadvantage of technical insurance is the encouragement which it gives to dishonesty. Property is wilfully destroyed to get insurance, thus increasing the net amount of property destroyed and increasing the cost of insurance to honest men. I have been informed that where a mill burns in a factory village the village hotel is almost sure to follow. The same informant states that a prudent insurance man of his acquaintance makes it a rule, on learning of the burning of a mill in a village, to cancel all insurance held by him on the hotel. It is estimated that from 35 to 50 per cent of the loss by fire in the United States is chargeable to incendiarism.

Technical insurance is attended with a large expense for management, and at present this is excessive. Not that insurance men make greater gains than other business men, but there are more agents for all kinds of insurance companies than there is economic justification for.

See also 79. The Early History of Insurance in England.

192. SPECULATIVE CONTRACTS

In our contractual society, speculative contracts form one of the leading ways of transferring and ultimately of reducing industrial risks. These speculative contracts are so numerous and so well known that a simple illustration will suffice. I decide to build a house. A contractor assumes the task. He then proceeds to make

sub-contracts with the purveyors of lumber, bricks, and other materials to the effect that these materials shall be delivered to him at a certain future time and at a certain price. The main contractor has thus contracted himself out of risk with reference to price changes in these materials.

Our contractor has thus been relieved of much of his risk, but has this operated to diminish the industrial risks of society? At first glance it would appear that the risks have merely been shifted. The social significance of the operation rests in the fact that the dealers in lumber, bricks, and other materials are presumably specialists who know in considerable detail the present and probable future conditions in their particular industries. They are thus presumably better judges of the risks of those particular enterprises than the main contractor, so that when the main contractor shifts risks to their shoulders it probably does mean a reduction in the total risks of society.

The foregoing illustration is typical. A man agrees to do a certain thing. He then contracts himself out of certain phases of the risk involved. True, the burden is merely transferred to someone else, but presumably this someone else is a specialist, and therein is the social defense.

It would be quite erroneous for us to think of the speculative contracts involved in trading on the organized exchanges as constituting the greater part of the speculative contracts of our day. The work of the organized exchanges has certain sensational elements, and volumes have been written upon these exchanges where sentences have not been written upon the vastly greater volume of speculative contracts entered into outside the limits of the organized exchange.

See also 179. Commercial Speculation.

193. HEDGING: A FORM OF SPECULATIVE CONTRACT

A1

All ownership of property involves the risk of loss from changes in value. The miller who, in December, buys wheat that will not be marketed as flour till April runs the chance that wheat and flour will both fall in price between the two dates, and so he will have to write off a loss.

Speculative trading permits the transferring of this burden from ordinary owners, e.g., millers, to a special class.

Taken by permission from F. M. Taylor, Principles of Economics, pp. 294–95. (University of Michigan, 1916.)

Illustration: A milling company buys 10,000 bu. of wheat on the Chicago exchange, said wheat to be delivered at once for use in the milling business. But the milling company wishes to confine itself strictly to its own business-milling-avoiding all speculation in wheat. It therefore wishes to shut out any chance of loss by a fall in the price of wheat and flour between the purchase of the wheat and the sale of the flour made from it. Accordingly, it sells 10,000 bu. for future delivery; i.e., agrees to deliver 10,000 bu. at a definite price three months from date. This having been done, whatever change takes place in the price of wheat, the milling company will neither gain nor lose; that is, whatever it gains or loses on the original purchase of cash wheat will be exactly offset by an equal loss or gain on the future sale.

Thus, suppose that, when the purchase is made, cash wheat is $1.00 per bu. and three-months futures $1.04. Further suppose that, when the three months have passed, wheat is $1.04. Under these conditions, the two transactions will come out as follows:

Evidently in this case there is neither gain nor loss from the transactions.

Suppose, now, that the price at the time of future delivery turns out to be $1.00; will the result be different?

Still again, suppose price to be 90 cents at time of future delivery; what result?