February 26, 2012
Adam Davidson has an interesting piece about how many low-paying jobs have a sort of lottery component where people are willing to accept low wages for a period of time in the hope that they will end up having a very high-paying job in the future. The best example of this sort of lottery system is probably the motion picture industry in Hollywood, where many people will spend years working in low-paying jobs in the hope that at some point they will make it big as an actor or director.
The piece then points out that many other occupations have a similar, if less extreme, lottery component. For example, lawyers are expected to work very hard as associates, but then can expect much higher pay if they get promoted to partner. Similarly, non-tenured faculty can face serious pressures to produce large amounts of research, before getting to enjoy the good life as a tenured faculty member.
Taking this view more broadly, most jobs have some sort of lottery component in the sense that there is a benefit to staying with a firm for a long period of time that workers lose if they leave, either by their choice or their employers. In more mundane jobs, the benefit might just be a pension, job security, and perhaps above-market pay for workers as they near retirement. The logic is that workers might get below-market pay when they are young and energetic, but if they stay with a firm long enough the situation is reversed as they slow down and their wage rises with seniority.
This point is interesting because it implies an obvious way that firms can increase their profit, at least in the short-term: take away the lottery prize. The savings on the prize is a pure short-term gain. In the case where a firm is keeping older, less productive, workers on the payroll and paying them a premium for seniority, ending the lottery prize (i.e. firing the workers) is a pure short-term gain. (This is of course a caricature — older workers are not necessarily less productive.) In the longer term it may not be a profit maximizing strategy, since younger workers will not make a commitment to mastering firm specific skills if they do not expect to be able to stay at the firm.
An article by Larry Summers and Andre Shliefer argued that breaking commitments of this sort was at the heart of the better-than-normal profits that private equity companies were able to earn. They argued that by breaking implicit contracts with workers and other stakeholders, private equity companies could increase profit at least in the short-run. If their intention is to sell out their stake at a profit, then a short-run gain would suit their purposes, even if the strategy might be harmful to the company and the economy in the long-run.
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