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Talent and Learning in Imperfect Markets

Final Report Summary - TLIM (Talent and Learning in Imperfect Markets)

In the empirical part of this project we have studied labor markets in light of an unusually broad measure of ability. We constructed a comprehensive data set that combines ability measures with educational choices, detailed labor market outcomes, and family backgrounds. The main ability measures are based on standardized tests that are administered to all military conscripts in Finland. They consist of what is, roughly, an intelligence test and a psychometric “personality” test. (All individuals were de-identified in the data.) We found that there are bundles of personality traits that are consistently conducive to individual economic success, even after controlling for factors such as cognitive ability and parental background. Personality traits are as predictive of later earnings as is intelligence, and occupational selection is an important mechanism through which they operate together with cognitive ability.

We discovered a “Flynn effect” for economically useful personality traits. (Flynn effect is the secular increase in intelligence test scores that has been widely documented; there is no scientific consensus on the causes of this phenomenon). This is surprising because higher subscores in a personality test are not so obviously about being “better” in the same sense as the subscores of the cognitive ability test, yet all those personality traits that are positively related with mid-career earnings have been consistently trending up across birth years. This increase is similar in magnitude to the simultaneous increase in intelligence; measured at a rate of about 0.3 standard deviations per decade. These trends hold consistently across socioeconomic backgrounds. At the same time their power in predicting career outcomes has been increasing. The merger of military aptitude test results with economic outcome data was finalized only late into the project, so analysis of this unique data is still ongoing and more results can be expected.

We have also found significant trends in the sectoral allocation of ability. For example, there is a disproportionate increase in the share of highest ability males that ends up working in financial and business service sectors, at the expense of sectors such as educational services.

In the theoretical part of this project we first studied sectoral choice in a model where agents face uncertain incomes with persistent risk. (When agents are as workers the “loss” means earning less than in an alternative sector.) From previous literature it was known that agents should persist in the risky sector well beyond the point where they are concurrently making losses, due to the possibility of positive earnings shocks later on. However, this requires agents to be able to sustain losses indefinitely, while in reality agents with a history of losses face constraints to their borrowing ability. We showed how the optimal behavior of agents is affected by the presence of a borrowing constraint, and how, at the aggregate level, this distortion results in “survival of the fattest” whereby previous lucky but currently unproductive agents linger on too long in a risky sector and crowd out entry by more productive entrants.

We also analyzed on-the-job learning in a multi-sector model economy. There is a potential efficiency gain from inter-sectoral turnover when sectors have different production costs and learning curves of different steepness. We identified a new type of market inefficiency that arises under imperfect financial markets. There is a bias towards too much turnover, that results in lower welfare and in lower average productivity, possibly even in both affected sectors.

We presented a model framework for analyzing the relation between distributions of income and house prices in an economy where houses are owner-occupied and have inherent quality differences. Each household owns one house and wishes to live in one house; thus everyone is potentially both a buyer and a seller. The framework enables welfare analysis in situations where changes or policies can be at least party capitalized into house/land prices, but houses are owner-occupied and of heterogeneous quality so that any distributional impact through houses also affects household welfare. We applied this model in an empirical study where we found that that recent increases in U.S. income inequality has likely had only a modest but negative impact on average house prices, and positive impact only in the top decile of house prices.