The Law of Diminishing Returns and Human Capital

Photo by Dziana Hasanbekava on Pexels.com

Most of us that have a rudimentary understanding of economics, are familiar with the concept of the Law of Diminishing Returns. It is quite evident that this premise is unquestionably applicable to physical goods. Does this enduring economic law also apply to intangible commodities? It is salient once a person has exhausted the optimal quantity of solid objects. This is conspicuous in the disutility of engaging in hoarding behavior. While the optimum number of chairs a person should furnish their home with is debatable and depend on several factors, it is obvious once a person has amassed too many. Once an individual has so many chairs that it makes restricts accessibility to certain rooms in the house, becomes a fire hazard, or the homeowner can no longer contain all of the objects they own within the confines of the physical structure of their house- then it is problematic. Then rightward shift from the equilibrium point is universally expressed. There is no foreseeable value in obtaining more or maintaining your current collection of chairs. The assessment of whether you have too many chairs is no longer a matter of aesthetic preferences, but a matter of physical limitations. It is easy to determine once we obtained too many physical goods. 

The saturation point is much more difficult to answer when about intangible goods (human capital, intellectual property, etc.). However, it could be argued that the Law of Diminishing does apply to human capital. The ultimate marketplace for human capital is the job market. Often we hear the term “saturation” be used to describe the labor market. Several factors can contribute to the overabundance of human capital available to employers. Periods of high unemployment leave firms with the ability to hire, a large pool of applicants to choose from. The saturation could be referring to a glut of similar skill sets or credentials. If history majors are a dime a dozen, but math majors are hard to come by, who is going to stand out in the job market? If everyone has basic Microsoft office skills, but there is one candidate in the resume heap that has an advanced certificate in Excel, needless to say, this will catch the eye of any hiring manager or human resources representative. 

Degrees and certificates are not so much human capital as documentation of skills and formal education. Couldn’t the soaking point of specific forms of human capital also be relevant to soft skills? Well, why not? If can be applied to credential and soft skills then it must apply to more innate qualities. Such as personality types. Pre-employment personality tests not only qualify if a candidate is a good match for a specific job role but also help to bring more balance to team dynamics. 

Going beyond even the job market or potential job prospects, human capital is integral in determining an individual’s overall trajectory in life. While other factors such as opportunity, motivation, and timing have a lot to do with success. Without the proper skills, most people will not rise above a certain point of attainment. One of the most coveted, but arguably overrated attributes in the panoply of human capital is general intelligence. General intelligence can only get a person so far. There is no one single factor that leads a person to success, but rather a multitude of different variables. The sum of the parts is greater than the whole certain applies. Providing some validation of  Scott Adams’s postulations regarding complementary skills. No one needs to a virtuoso, but it is better to be reasonably good at many related skills than to fully master one. General intelligence is the archetypal example of being a master of one domain. We all have heard the platitude “… jack of all trades, master of none…” so frequently that it is deeply ingrained in our subconscious. However, this old saying has little applicability to the real world. It isn’t the smartest or the most diligent among us that succeed. Then again, the village idiot and the local ne’er-do-well burnout aren’t the ones rising to the top either.

Malcolm Gladwell’s book Outliers (2008) presents an intriguing example of why general intelligence alone will not ensure success. Gladwell details the near-tragic trials and tribulations of Christopher Langan. A man who is a bona fide genius. Despite his expansive and impressive intellect he never had the opportunity to thrive as a universally praised academic. Langan boosted an IQ of 195 shadowing the IQ of Albert Einstein forty-five points (p.70). As impressive as it sounds to have an IQ of 195, there is one important point to remember. A veteran scientist with an IQ of 130 is equally as likely as a colleague with an IQ of 180 to win a Nobel Prize (p.80). Meaning that Lagan’s intelligence while awe-inspiring could even be viewed as being superfluous. If a person with an IQ thirty points lower than Langan can be a Nobel laureate what value does the extra IQ points effectively bring to the table? 

Despite Langan’s intimidating intellect he failed to even obtain an undergraduate degree. This was due to a string of unfortunate shifts in his vicissitudes. One notable incident transpired when he was enrolled at Montana State, he had car troubles and could not make his morning classes. He had a neighbor who offered to give him rides in the afternoon to school. Regardless of how much cajoled and begged the dean he was not allowed to change his class schedule and was forced to withdraw from his program (p.94-95). Langan’s foil must be Robert Oppenheimer who worked on the development of the atomic bomb during World War II (p.97). Here was a man who as a student attempted to murder his tutored (p.98). Not only did he get away with it, but later on after he completed his graduate program he managed to get on the prestigious Manhattan Project. It is evident his past transgressions did not dampen his career in any way. What truly separates both these men from one another? Both men were exceptionally bright, but one man couldn’t even convince his dean to do something as innocuous as changing his class schedule. Another got away with attempted murder. The difference was that Oppenheimer had a greater degree of practical intelligence (p.101).

The comparison between these two men illustrates that not only is there a ceiling in the benefits of having high general intelligence. There are also limitations if the only skills you have are related to general intelligence. Without practical knowledge, a robust IQ is tantamount to be a weight. We all need the precepts requisite to tactfully navigate the world. In the absence of this scaffolding, our intelligence is of little use and only serves to weigh us down.

Success By Default is Not Truly Success

Photo by Anna Tarazevich on Pexels.com

In terms of formulating effective rules, one needs to have a panoramic understanding of the potential consequences. Even the downstream outcomes are not easily foreseen. Providing some validation of F.A. Hayek’s notion of the Pretense of Knowledge. No one person, organization, or collection of governing institutions has all of the information required to plan for every scenario. Making it foolhardy to enact inflexible rules that operate as if the definite outcomes can be methodically calculated. Treading down the path of the socialist calculation debate is fruitless as the refutations on both sides of the aisle have already been exhausted. The fall of the Soviet Union alone should serve as a historical anecdote of the fallacy of planned economies.

It should be noted that information asymmetries and unforeseeable outcomes are a natural consequence of having limited information. Explaining phenomena such as cobra effects, because certain repercussions cannot be known until it is too late. These distorted outcomes as the result of flawed rules can happen on a much smaller scale than that of the national economy or a country’s legal system. Something as mundane as a birthdate cutoff to participate in youth hockey can spur some surprise inequities in the trajectory of young hockey players. This example springing from the pages of Malcolm Gladwell’s 2008 book Outliers gives us some keen insights into the potential for implicit flaws in rule formulation. Gladwell details the observations of psychologist Roger Barnsley (p.22-23) upon perusing the program of the Canadian national youth hockey championship. Barnsley noticed that the majority of the players had birthdays ranging between January and March. Is it possible that there is a certain qualitative factor distinguishing children with birthdays earlier on in the year? If we examine the zodiac symbols of those born in January and February there are characteristics that are conducive to success. However, there is little scientific merit to astrology anyhow. Barnsley had another explanation for this discrepancy between Canadian Hockey players born in January versus July. 

Barnsley astutely directs us towards the factor of birthday cutoffs for eligibility to play youth hockey in Canada. This fact was substantiated when Barnsley discovered that roughly 40 percent of all elite hockey players were born between January-March, 30 percent between April-June (p.23) Demonstrating the role of the individual player’s birthday in determining success. Having a January first cutoff, privileged prospective players born in the earlier months of the year (p.24). The main difference being that the boys born in earlier months were more physically mature. In turn, received more attention from the coaches lending this dynamic to an early delineation between talented and untalented players (p.25). Due to the difference in age eligibility cutoffs in American youth football and basketball leagues, they did not exhibit the same distortions in the distribution of talent (p.26). Engendering a Matthew Effect or what is otherwise known as an accumulative advantage. Adam Smith even points to the concept of accumulative advantage in The Wealth of NationsExplaining how in a sense the poor pay the price for the poor decisions of their forefathers. 

Many proponents of meritocratic social arrangements may scoff at the idea of making rules that are fair. However, if the rules are providing a lopsided advantage to one group, are the results truly the result of superior performance or the distortion created by the rules? Few would ever view the occurrence of instances of regulatory capture or rent-seeking as a triumph of free-market competition. Rather just the opposite, it is an example of interest groups bending the rules to suit their own needs. Careful consideration needs to be made in how we set and enforce rules to avoid distorted effects that handsomely benefit a few and harm a great many. Gladwell succinctly sums up this point very eloquently: 

“Because we cling to the idea that success is a simple function of individual merit and that the world in which we all group up and then we choose to write society don’t matter at all.” (p.33)

While variables such as luck, talent, ingenuity, and hard work can all have a role in success, we cannot forget that how the rules are written can also have an inseparable impact on outcomes. Even rules that are inadvertently written in a manner to favor one group over another without consideration of merit is a flawed rule. Marred by an unforeseeable blind spot that nevertheless has generated distorted outcomes. These outcomes are not truly the byproduct of talent or work ethic but by technicalities that create illusory perceptions of actual skill.