notes-econ-inequalityAndConcentratedBets

one thing that seems odd about the economy is that rich people with powerful jobs are paid so much more and are given so many more opportunities than others. People tend to think this is about 'cronyism' but i think it's a rational response by the other people (i'm not saying it's necessarily good for society):

Let's assume that there are many economic projects waiting to be done which (a) don't require too many decisions at the top, strategic level, (b) benefit from wholistic strategic thinking for those decisions, and (c) require way too much total work to be done by one person. An example of something that fails test (a) would be allocating capital in the economy as a whole; central planners either can't get enough information (e.g. every consumer's complete set of demand preferences, and every supplier's complete set of potential products and marginal costs at various production levels), or don't have enough time to think through it all (eg. to learn about every single up-and-coming new technology), or aren't properly incentivized, or think too homogeneously. An example that fails (b) is a team of marathon runners; perhaps there are some economies of scale and some benefits of being on a team together that merits training together under one coach, but it's not like what one runner does during the race can decicively help or hurt another one; the team doesn't need to have a coherent strategy.

Under the above assumptions, it seems like a reasonable thing to do is to form companies, and to have a hierarchical decision-making structure in which a small number of people think about strategy and decide what to do (this is not necessarily the only solution; one could imagine some alternate democractic voting procedure in which there is no fixed set of decision-makers; there are various arguments for and against that alternative; but for now, just observe that the solution of having a small number of decision-makers seems to be the one mostly used in our current society).

Now, because the power structure is hierarchical, it's very important to get the right decisions being made at the top, which means it's important to get the best decision-makers into power. Let's say that are betting, and you have a choice to bet on horse A or on horse B, and you know for a fact that there's a 55% chance that horse A is faster than horse B, and a 45% chance that horse B is faster than horse A. Which one do you bet on? Do you put all your money on horse A? Or do you put 55% of your money on horse A, and 45% on horse B, or something like that? You can see why someone might put all of their money on horse A. Similarly, boards of companies want to get the very best executives that they can out of their pool of candidates.

If we further assume that the best way to assess an executive is to look at their past performance in similarly-sized companies, then we see that it makes sense to hire almost exclusively people who have already been working in similar powerful positions in the past.

Now, how much do we pay these people? Well, they've made a lot of money in their previous jobs, so in order to be sure to incentivize them to care, we'd better pay them at least on that scale. Since one person is controlling the vast resources of an entire company, them being a little better or worse will have effects on the scale of the company's revenue, so paying them a little more or less is worth it, as long as that number is a small fraction of the company's total revenue.

Let's make one additional assumption: that there is a psychological effect were if you only expect and demand average performance from an employee, your payoff is worse than if you expect and demand above-average performance, even if the incentives are the same in both cases. Executives are employees. So this means that you should demand and expect above-average performance from executives. But if you really expect that, then you have to be willing to pay above the average market price. If you were not willing to pay above the average market price, that would be a signal that you don't REALLY seriously expect above-average performance, no matter what you say. In this situation, companies can benefit a lot by paying their CEOs above the going rate for CEO pay in their industry. Since all the companies are doing the same thing, CEO pay will increase quickly until it is really as high as companies can possibly bear to pay them.

So, we see that it seems to be in the best interests of company boards who are hiring executives to focus only on candidates who already have powerful jobs and get paid a ton of money, and then to pay them a ton of money.

(in addition to the usual costs to society that people talk about, namely, the inequality created by giving so much wealth and power to those who are already wealthy and powerful, i'd like to mention another cost: this system provides very heavy incentives to work very hard, and tends to only give the CEO position to people who make big sacrifices in other areas of their life for their career; these people are then given a great deal of power over the lives of other employees; but socially, these people are outliers, in the sense that they care about career much more than the typical human (in other words, they assign a lower utility to leisure than the typical human does); because these people have disproportionate power, they push the economy into a configuration where more work is demanded and less leisure afforded than it would be if the typical human had that power (in other words, utility is not being maximized because leisure is undervalued by the primary decision-makers))