21 February 2012

The Economics And Politics Of Talent Discovery And Term Limits

Tyler Cohen calls attention to the paper "Superstars and Mediocrities:
Market Failure in The Discovery of Talent"
by Marko Terviö , published in 2009. It isn't often that you see something new under the sun in economics, but this comes pretty close.

The essence of the argument is that firms in competitive markets underinvest in discovering new talents, particularly in situations where (1) there is no good way to discern talent other than putting someone in a job and seeing how successful they turn out to be, often in the public eye, and (2) talent is quickly apparent once someone is put on the job. Since, the supply of revealed talent is often small for high profile positions like CEOs and Hollywood Stars, and the risk that a novice will flop are great, it is safer to try to hire someone with revealed talent, rather than a novice. Even if there are many more talented people out there waiting to be discovered, a firm may want to take a risk on a merely mediocre sure thing.

Furthermore, firms lack an incentive to take a risk on novice talent because is the novice turns out to be a flop, the firm has invested in a hire that turned out to be a failure, while if the novice turns out to be a success, the legal barriers to entering into long term contracts for personal services means that the person with a newly revealed talent may minize the return to the firm that gave them a break by insisting on the high compensation available to revealed talent rather than the low compensation available to novices with unrevealed talent.

Thus, investing in discovering new talent may be a bad economic decision for firms in competitive markets.

In contrast, under situations like the studio system of Hollywood in the 1920s until the 1940s, where talent is hired for seven year contracts with enforceable non-compete clauses that allow the studio to pay low capped wages during the trial period, even if the person is a superstar (while allow the studio to terminate the contract early, ending the salary and the non-compete of the person under contract), the potential up side gain for discovering someone gave Hollywood studios an incentive to invest in discovering new talent.

Alternately, he notes that there are other ways one can break the barriers to entry for undiscovered talent other than long term contracts.

One is to allow people to buy jobs, something that actually does happen in the world of business where you can start or buy a company (the entertainment equivalent would be to rent Carnegie Hall with your own money), on the theory that talented people will pay to get a chance to prove their stuff, while mediocre non-novices will be happy to sell their opportunties to someone else and get out.

Another is that the disincentive to invest in discovering talent declines when there is a monopoly, collusive market, or simply a market in which some players of outsized market power. Since firms in these kinds of markets can realistically expect to receive at least their share of the industry-wide benefits of having an industry in which more talent is discovered, they have an incentive to participate in processes that discover talent even if it is costly to do so. Disney's quasi-studio system is one example. The quasi-collusive market of professional sports leagues is another. One could argue that this model helps explain why large law firms with great market power are willing to pay so much to new associate attorneys. And, one could also apply this insight to industry monopolist employers like the military.

He also argues that market failure in discovering new talent means that merely mediocre people who managed to get hired in the past will be paid more and have longer careers, and that the rewards to being a discovered superstar will be greater because fewer superstars will have been discovered.

Indeed, the author suggests that insufficient investment in talent discovery may be at the root of superstar economic rents (i.e. payments in excess of what their personal marginal economic contribution can explain) in a variety of professions such as entertainment and senior management for big businesses, situations that have previously been attributed to other economic causes.

The author doesn't extend his analysis to politics, but the same kind of analysis can be applied to thinking about how term limits work in politics. Rather than compelling talented novices to provide benefits for a prolonged period for the benefit of the government, it kicks people out, talented or not, to make room for new talented novices to move in. The people whose political talents are revealed in this process may be sought for other political jobs down the line, perhaps running for higher offices that also pay better. The people whose political talents prove to be lacking don't get re-elected (Doug Bruce comes to mind), and the people whose political talents are mediocre, who might be re-elected indefinitely closing the door to new talent that is superior, are forced to end their careers early by getting out (as many do) or moving up. Thus, one of the important roles that a term limited state legislature can provide is to serve as a "farm team" in which real life political talent can be discovered, leading to better talent at the top of that industry.

More analysis of talent discovery issues in sports and with broader implications can be found here and summed up with these conclusions, which pointed out the superiority of the minor league system used by baseball to the college sports system of identifying pro-sports talent in football and basketball:

An important sorting mechanism for labor market sorting is real-time work. Regardless of your school pedigree, most prestige professions (lawyers, financial managers, professors, etc.) have up-or-out rules after a period of probationary employment where skill is evaluated in real world action. . . . . I wonder if the de facto college minor-league systems of basketball and football hinder the sorting of talent so that the Jeremy Lins and Kurt Warners of the world often don’t survive. Thus, another downside of these college sports monopsonies is an inferior allocation of talent at the next level.

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