Respect Capitalism

Perhaps the most interesting area of economics of mine and simultaneously the area in which I have the least formal education is the labor market - specifically the IT labor market. Recently Bruce Webster made some observations about current IT labor strategies that I find to be spot-on: The Wetware Crisis: the Dead Sea Effect. In the article, Bruce describes the current IT labor retention situation much like the dead sea - eventually the true talent leaves and the “residual” is left behind, happy that they have a secure job.

Though I have no statistical evidence, based purely on my experience, I intuitively believe that variance in productivity or “output” in IT - and in software engineering in particular - is significantly higher than most other fields, enough for a standard deviation of orders of magnitudes. I find it entirely reasonable to believe that a talented software engineer can easily produce literally 20x more “output” than a lower-mediocre developer. I don’t think the labor market in IT has entirely captured or adjusted for this fact and is instead stuck representing variance in productivity that is more common in traditional jobs.

It is no wonder then that talented people are leaving large organizations in droves when they are not being properly compensated (salary, work environment, intellectual stimulation, etc.), mostly as a result of managers failing to recognize the important of talent in organizations and the huge variance in applicants’ ability. Bruce writes:

“Large companies tend to lose the really talented IT engineers and hold onto the less talented ones, when they should been actively seeking to do just the opposite. And the effect tends to be self-reinforcing: the worse an IT shop becomes, the harder it is to get really talented and effective IT engineers to join it and the harder it is to retain them if they do.”

Indeed the effect is self-reinforcing because environments not conducive to intellectual stimulation have a snowball effect.

To me the differences in hiring practices between smaller agile startups and larger more “traditional” companies are striking. A few points; but first note that I am using the term “large company” to represent not necessarily a company that is large but a “traditional” company not in-step with what I believe to be effective hiring IT strategy, certainly this would not apply to companies like Microsoft and Google which are of course “large”:

1. Large companies tend to overestimate equality - in many facets, but in particular workforce talent. This leads them to believe this variance in ability is significantly smaller than it is.
2. Large companies with IT departments feel pressured to have compensation variance in IT parallel compensation variance in other departments, even when there is no strictly economic rationale for doing so. Doing this emphasizes the continuum extremes: talented people want to leave for higher-paying opportunities and the lesser-able want to stay and hold on to their high salary (important: high relative to the work output, measured in comparison others in the department).
3. Large companies tend to over-emphasize the “work your way up” approach to salary levels, starting most entry-level applicants at roughly the same rate with yearly increases or bonuses, completely ignorant to actual work output or high differences in starting ability.
4. Large companies are less frequent to acknowledge or point out differences in ability and output at work as doing so is politically incorrect or something that is just “not talked about”.
5. Large companies are for some reason less likely to fire people for reasons of “opportunity cost” - opportunity of hiring better people. Instead people are only fired if they are actively holding an organization back. Firing someone because they are not producing work output per dollar that is on par with either another existing person or another person they could get is an entirely reasonable and economically-justified (in many cases) reason for firing someone, but this just doesn’t happen because of many management and personal reasons (”But I feel bad!”). More on this in the future!

In contrast, many smaller companies and start-ups seem have a much better ability to recognize of this fact: talented people, dollar-for-dollar often simply bring significantly more value to a company, after compensation, than average or lower-quality people. Ultimately this reflects an imbalance in the labor market which I’ll explore later, but you’ll notice that many smaller companies will pay for and try to get younger people based on their talent and experience, not on their age. For many companies there is no “typical” salary - you are paid what you are believed to be worth. These companies actively seek out talented people whereas “large companies” want their applicants to make themselves “worthy” to work there - the completely wrong approach.

Many small companies are reaping the benefits of this labor market imbalance and doing very well. Companies like Google who deliberately seek out high talent and pay their developers extremely well are sucking up talent from other companies not doing so and as a result becoming extremely successful even around a business model that many Wall Street analyzes puzzle over.

By no means do I think what I’ve just described applies to all “large companies” and I use that term very loosely. More accurately, there are companies that “get it” and companies that don’t. The great thing about the free competitive market is that the companies that get it will succeed and those that don’t won’t. In the next few decades companies are going to need to wise up or face major problems with the effectiveness and cost of their IT departments.

Ever notice that at the barnes & noble cafe when you leave your size ambiguous they never ask “what size would you like?”  Instead they say, “would you like a large?” Presumably they do so with the expectation that people are more likely to respond in the affirmative to a question like “would you like a large?” than actually give “large” as their answer if asked what size they would like.  There is significant evidence that how a question is asked has an extremely large impact on the statistical results of that question.  What’s more is that a large is actually a venti, not a grande as most people would expect (considering grande is what actually means large in Italian…)  This is an excellent and intelligent way for Barnes & Noble to capture more consumer surplus - I always smile when I hear this question being asked and the customer unsurely replying “uh.. yeah”. 

Welcome to my new blog! To kick this off, I’ll start with an introduction and an overview of my philosophy:

My name is Ben Hughes and I’m currently a senior at Rochester Institute of Technology, finishing up a double major in Information Technology and Economics. I’m a Ruby on Rails web developer, jazz musician, tennis player, and amateur economist interested in policy issues. I am philosophically libertarian and believe that the free market works better than most non-economists assume. Capitalism, or the free market, often deserves more “respect” than most people grant it, hence the name of this blog.

Let me be clear that the opinions presented and analysis of issues discussed in this blog are based on pure armchair reasoning of issues that do not necessarily represent “hard science” with empirically provable results. I am not a Ph. D. economist and am not interested in publishing research papers backed by hard data and mathematics; I am far more interested in “thinking outside the box” and putting seemingly non-economic issues into an economic light. Some of the most interesting books I’ve ever read followed this direction.

I strongly believe in greater public understanding of economics as a thought process, or “thinking like an economist”. Economics is not business and it is not finance: it is the study of scarcity and how resources are (hopefully optimally) allocated, a fact rarely acknowledged by non-economists. I think it’s a shame that many high schools require four years of study in literature while requiring virtually no study in economics, statistics, or probability – all issues that better-enlighten the public and through democratic voting have drastic consequences on the well-being of millions of people.

Part of my drive for writing this blog arises from the seemingly widespread misconceptions of economic cause and effect that spread like wildfire throughout the popular media, but are seldom properly addressed by journalists. With all the time being dumped into research of dubious practical merit, I think economists should take a more active role in policy issues by aiding in greater understanding of the “dismal science”.