The Talent Trap: Escaping Adverse Selection’s Grip in Hiring

 

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As an employee, have you ever felt that your output doesn’t meet the wages you are receiving? Conversely, as an employer, do you feel that strong CV’s are uncorrelated with high levels of productivity? This might be a strong indicator that you have fallen victim to the talent trap.

Defining the Talent Trap

‘The talent trap’ refers to the situation where employers, due to the existence of asymmetric information in the labour market, adversely select candidates, ultimately leading to market failure as individual talent and skills are not being properly utilised in the productive process.

• Asymmetric Information: Refers to the situation where in an exchange, one party possesses more knowledge than the other. In the context of this article, employees possess more information about their skills than employers.
• Adverse Selection: Occurs as a result of asymmetric information. It leads to an unequal distribution of benefits to both parties in an exchange.

Adverse selection, especially within technical industries that require specialised labour, is more prominent than ever. This affects everyone involved in the productive process, ranging from the human capital, who are not getting properly compensated for their work, to the shareholders, who miss out from achieving potential greater profits. One thing is clear, the talent trap is growing and nobody is benefiting from it.

Why does this happen in the labour market?

In the labour market, employers search to find the best candidate for a specific job, which poses the question. How can they accurately know which potential candidate is the best? The method that employers have traditionally used has been to rely strongly on academic credentials when hiring employees. The reason for this is simple: academic performance has historically been a great tool to demonstrate talent and productivity. However, in recent years academic performance has become less credible, and causes greater adverse selection between an employer and employee. Employers cannot know the real quality of employees, hence the talent trap occurs.

• First, due to the consequences of COVID-19, in combination with the goal of moving towards modernity, many academic institutions decided to change their examination methods from in-person exams to online exams. Despite the potential benefits of this sudden change, it came with an obvious downside; the increased chance of cheating. In fact, the percentage of students that achieved a 1st class degree jumped from 28% in 2019 to 35% in 2020, an unprecedented 7% increase1. In a similar sense, many professional firms have also made the move from in-person towards online. The creation of online interviews and remote internships have been on the rise since 2020 which, Similarly to academia, increase the opportunities for cheating, aggravating imperfect information and thereby intensifying adverse selection in the labour market.

Figure 1

Source: Office for National Statistics

• Second, the rapid development of AI is also a problem. For example, as of 2023, 53% of students admit to using AI to generate material for assessed work. There are no signs of this stopping, the rapid growth of AI has allowed students to inflate their grades, projects and CV’s which, despite increasing the average grade of candidates, decreases their overall quality. Though the future is impossible to predict, this could diminish candidates’ autonomy and critical thinking skills, negatively impacting their individual performance and overall quality of the workforce.

Why does it matter?

So, as an employer, why does this matter to your firm? Asymmetric information, or as we've coined it ‘The talent trap’ may lead to you not hiring the best person for the job. Technically speaking, you may be overpaying for an unproductive employee. For example, imagine there are two potential candidates for a job, Person A and Person B. Person A achieved a better grade in their undergraduate degree so, naturally, you give the job to them. However, there is a potential issue with this:

Did Person A achieve that grade legitimately? Could they have used AI to complete their dissertation or did they complete an online exam with coursemates?

It is crucial to consider these factors, otherwise you may hire the candidate that is least suitable for the job leading to lower productivity and less output, revenue and growth. Consequently, High-quality employees may be underpaid or underutilised, while low-quality employees may be overpaid or overutilised. Over time, this can impact the overall output and efficiency of the market, meaning resources are not allocated efficiently. This prevents the market from operating in an optimal way, as there is a clear misallocation of talents, causing the market failure.

Avoiding the Talent Trap: Is it Possible?

This leads to the question that many employers are asking themselves: if there is a noticeable degree of asymmetric information in the labour market, how can they avoid the talent trap and hence achieve economic efficiency? A possible solution, that many employers are already utilising, is to prioritise individual skills and expertise, using a mixture of behavioural questions and situational judgement questions over the standard competency tests (Chamorro-Premizic and Frankiewica, 2019), in other words, prioritising talent over CV’s. A recent survey by ManpowerGroup involving 2,000 companies in the US revealed that 50% of firms placed social skills such as customer service or adaptability as the most important factors when interviewing potential future employees (Manpower Group Solution, 2018). That being said, it would be a mistake to underestimate the value of a strong CV as a market signalling tool. It has been repeatedly demonstrated that high academic achievement in university is strongly correlated with high levels of productivity in the labour market; in fact, the graduate employment rate has stayed relatively constant at around 87% for the past two decades (Office for National Statistics, 2023).

Figure 3

As an employer, you will never have perfect information about a candidate available to you, but by implementing effective interview techniques you can certainly maximise the reliability of the information. This will ensure you are only hiring the most productive candidates available who will provide far greater benefits to the business and be much better value for money.

Bibliography

Arctic Shores. 2023. ‘ChatGPT vs Situational Judgement Tests: How it performs vs a human’.

Board, S. Meyer-ter-Vehn, M. Sadzik, T. 2023. ‘Recruiting Talent’. UCLA Economics.

Chamorro-Premuzic, T. Frankiewicz, B. 2019. ‘Does Higher Education Still Prepare People for Jobs?’. Harvard Business Review

Freeman, J. 2024. ‘Student views on Generative AI in Higher Education’. Higher Education Policy Institute.

ManpowerGroup Solutions’. 2018. ‘The Rise of the Well-Informed Candidate’.

Office for National Statistics. 2023. ‘Graduate Labour Market Statistics’.

Office for National Statistics. 2023. ‘Undergraduate degree results’.