Superstars and Mediocrities: Market Failure in The Discovery of Talent

A basic problem facing most labor markets is that workers can neither commit to long-term wage contracts nor can they self …nance the costs of production. I study the e¤ects of these imperfections when talent is industry-speci…c, it can only be revealed on the job, and once learned becomes public information. I show that …rms bid excessively for the pool of incumbent workers at the expense of trying out new talent. The workforce is then plagued with an unfavorable selection of individuals: there are too many mediocre workers, whose talent is not high enough to justify them crowding out novice workers with lower expected talent but with more upside potential. The result is an ine¢ ciently low level of output coupled with higher wages for known high talents. This problem is most severe where information about talent is initially very imprecise and the complementary costs of production are high. I argue that high incomes in professions such as entertainment, management, and entrepreneurship, may be explained by the nature of the talent revelation process, rather than by an underlying scarcity of talent. (JEL D30, J31, J6, M5) An earlier version of this paper circulated under the title “Mediocrity in Talent Markets.”I am grateful to Abhijit Banerjee, Emek Basker, Shawn Cole, Ernesto Dal Bó, Frank Fisher, Robert Gibbons, Ben Hermalin, Lakshmi Iyer, Simon Johnson, Michael Katz, Jonathan Leonard, Timothy Mueller, Eric Van den Steen, Scott Stern, Steve Tadelis, Johan Walden, Florian Zettelmeyer, and especially Bengt Holmström and David Autor for comments and suggestions. I thank the Yrjö Jahnsson Foundation for …nancial support.