The Trouble With Human Capital Theory

In my last post, I skewered human capital theory by comparing it to the pseudoscience of eugenics. Here’s a follow up — a presentation called The Trouble With Human Capital Theory. It’s a talk I gave to the SEEFAR research center at the Kedge Business School. I thank Christophe Faugère for inviting me to speak.

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  1. Some thoughts.

    1) You compare the inequality of productivity, objectively measured i.e. for the same kind of work, with overall income inequality. You find little overlap between the two and conclude that productivity cannot explain income differences. I think this is methodologically unsound. A sound comparison would be between inequality of productivity versus income for workers *who do the same kind of work*. The obvious problem is that this won’t tell us anything about income differences between different kinds of work. So, taken as evidence against a productivity -> income causality, this is pretty weak.

    2) It is not hard to come up with plausible theories to explain *why* hierarchical rank is so strongly correlated with income. In order to achive the best possible outcome, it is necessary that people work in close coordination with each other. Coordinating the work done by subordinates is (at least nominally) the prime task of those higher up in the hierarchy. Thus, the higher up in the hierarchy, the more far-reaching the consequences of ones actions (decisions, behavior): a bad leader has the potential to reduce the effectiveness of everyone under their command, while a good one will make them achieve their full potential. The scricter the hierarchy, the stronger this effect becomes. The etreme example is the military: A single front-line soldier can hardly make a difference between victory or loss, but a single general’s decision can determine the outcome of a battle, and a single supreme commander’s that of the whole war.

    So, in the interest of the best possible outcome, it is much more important to have good managers/commanders, than it is to have good workers/soldiers. To drive the selection process, a proven method is to make people compete for the higher positions. And to motivate people to compete, you reward higher positions with privileges: higher social status, higher income, etc.

    I have so far phrased this in a teleological manner, as if this were something consciously designed, but one could easily reformulate it in terms of group selection: organizations that reward higher rank positions with prvileges and thus strengthen the competition for them will tend to outperform those that don’t and will thus replace them in the long run.

    Of course, as everyone knows, making people compete for positions in a hierarchy also has a lot of downsides. Excessive competition for promotion can lead to destructive behavior (making yourself look better by successfully undermining the work of your competitors). This may be one of the reasons why CEO positions tend to be filled with people from outside the company. And since it is the higher-ups that evaluate performance and decide who gets promoted, there is a certain incentive to promote people according to whether that will help the superior in its struggle against their own competitors, rather than their ability to lead i.e. coordinate the work of others.

    3) I think it is important to stress that this is all about differences in employee income. None of these considerations have anything to do with how and why ownership alone (that is, absentee ownership) leads to income (and how large that income is). That is, apart from stating that this kind of income has even less to do with productivity.

    • Hi bf,

      Yes, I’m aware that the comparison you mention is not totally rigorous. I will point out, though, that as soon as you realize you can’t objectively compare the productivity of workers who do different tasks, that means the idea that productivity causes income is untestable. But my example is meant as a thought experiment to see what happens if we ignore this problem and force ahead anyway.

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