Wednesday, December 28, 2011

Cognitive biases and winner takes all society

Lane Kenworthy has an interesting post where he questions conventional wisdom on the winner-takes-all economy, where a few people at the top of each industry have seen massive increases in their incomes, whereas the take-home paychecks of the rest have remained stagnant.

Supporters of this trend argue that the differential is a well-deserved premium since it is a reward for hardwork and inventiveness. This line of analysis attributes a disproportionately high weight to the good performance of the company (it is another matter that even those with below average performance claim this premium!) to the quality of leadership. Supporters of the skewed financial market compensation in general, and executive compensation, in particular, have argued that the high financial rewards are a reflection of their performance and the innovation that goes along with it.

Since Apple and Steve Jobs are the modern benchmarks for innovation, Prof Kenworthy writes in the context of the discussion on what drove the late Jobs,

"Would Jobs and his teams of engineers, designers, and others at Apple have worked as hard as they did to create these new products and bring them to market in the absence of massive winner-take-all financial incentives... Jobs himself seems to have been driven mainly by a passion for the products, for winning the competitive battle, and perhaps for status among peers. The satisfaction of achieving excellence and of beating one’s opponents appears to have been far more important than monetary compensation. Excellence and victory were their own reward, rather than a means to the end of financial riches... The rise of winner-take-all compensation occurred simultaneously with surges in innovation and productivity in certain fields, but that doesn’t mean it was the cause of those surges."

I agree with Prof Kenworthy and am inclined to the argument that innovation at the highest levels is driven more by passion and desire for peer recognition than by financial rewards. Here are three more observations.

1. The fixation on financial rewards may be an example of availability bias at work. In the mainstream discourse, financial rewards have a deeply entrenched association with achievements and innovations. So there is a natural tendency to subliminally associate any innovation with financial rewards.

2. Further, there is also the strong correlation-causation bias in the winner-take-all interpretation. A successful innovation would naturally result in a flow of financial rewards. So, given the entrenched availability biases about financial rewards causing innovation, the immediate impulse is to attribute the innovation itself to the financial reward.

3. A wage premium is necessary to build up high quality teams that can collaborate in the development of innovative products. However, while intuitively true, this may require more deeper analysis. It would be instructive to examine the great modern day innovations, and assess the relative roles of large team-work and individual genius, in the genesis of the innovation. I suspect that the latter would bear a disproportionate share of the credit for such innnovations. It may be too much of a stretch to argue that Larry Page or Mark Zuckerburg or Niklas Zennström were motivated predominantly by the attractions of a winner-takes-all system and not their inherent personal motivation.

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