From what I've seen, this is how most bootstrapped small-businesses hire. We find someone promising, we throw them a few smaller contracts, and then if we like them, we offer to hire them full time on a w2.
This is what I've been doing forever, and as far as I can tell, this is extremely common for businesses of my size with my ownership structure.
I think it's less common for large corporations because the definition of 'contractor' is, well, pretty unclear, so hiring someone direct on a 1099 is very risky, and hiring someone out of a body shop is usually quite expensive. (That, and most good people won't bother with you if you want them to go through a body shop.)
I just hired (or rather, gave a contract task to) a guy that has a full-time non-technical job and a few technical (unpaid) positions. He's going to be part-time (as a paid technical person) for me.
But yeah, I see what you are saying; You have a really hard time hiring known good people this way; known good people, if they want full-time work can pretty much write their own tickets without working two jobs for a while first. Known good people who want to be contractors, generally speaking, want to be contractors and don't want to be employees.
Of course, most businesses of my revenue/in my market simply can't hire known good people; we can't afford their rates.
Businesses at my end of the market are betting that we can get good people that other people don't think are good; so really, an extended screening process is more important than if you can pay google rates to begin with.
None the less, there are many small businesses that operate like this; we do find good people; of course, we also end up kissing some frogs, and when we do find good people, they don't stick around forever; people with the ability to pay well eventually notice they are good.
I think it works out okay for all involved; most companies that can afford to pay the rates 'known good' people demand simply won't look at people who have been unemployed (or employed doing something non-technical) for a while, or people who don't have experience; that's where I get most of my people. And after working for me for a while? they have something technical to put on their resume, and people who can pay real money look at them seriously.
This is what I've been doing forever, and as far as I can tell, this is extremely common for businesses of my size with my ownership structure.
I think it's less common for large corporations because the definition of 'contractor' is, well, pretty unclear, so hiring someone direct on a 1099 is very risky, and hiring someone out of a body shop is usually quite expensive. (That, and most good people won't bother with you if you want them to go through a body shop.)