Chapter 3: Investment in Skills

Chapter 3: Investment in Skills13/29/2020Chapter 3: Investment in SkillsMatchingInvestments in EducationEffects of Costs and BenefitsCostsInterest RatesCareer LengthSpecialization of Human CapitalEffectiveness of LearningWas Benjamin Franklin Correct? Investments in On-The-Job Training General versus Firm-Specific Human Capital Special case: Intellectual Property Who should pay for Training?EducationImplicit cost to employee and benefit to employer MatchingRecruitingArbitrageOn-the-job trainingGeneral Human CapitalHuman Capital that is partly or fully firm specific Implications of On-the-Job trainingTurnoverInvestmentCompensationLabor Market ThicknessFirm SizeRent Sharing and CompensationImplicit ContractingSummary 23/29/2020Chapter 3 – Investment in SkillsAfter completing this chapter, you will be able to address the following:When should firms pay for training?What is the optimum level of job training? What is the Age-Earnings profile, typically?How can a firm’s reputation affect its training costs?33/29/2020Investments in Education 43/29/2020Stay-in-School ProblemKi: Wage in year I with diplomaJi: Wage in year I without diplomaC0: Costs of staying in school, incurred nowT: Total years to retirementr: Discount rate 53/29/2020Stay-in-School ProblemBenefits from investing in human capitalIncreased future incomeCostsDirect costs of trainingForgone income while trainingFuture benefits and costs must be discounted for an appropriate comparison63/29/2020The Wage-Schooling RelationshipThe salaries firms are willing to pay workers depend on the level of schooling.Properties of the wage-schooling relationshipThe wage-schooling plot is upward-slopingThe slope of the wage vs. schooling indicates the increase in earnings associated with an additional year of education.The wage-schooling plot is concave, reflecting diminishing returns to schooling73/29/2020Wages vs. Schooling01314181230,00020,00023,00025,000Years of SchoolingDollars83/29/2020The Effect of AbilitiesWhen two people have different abilities with respect to education.The same investment will produce different future streams of income.Person 1 (high ability): $10,000 investment boosts income by $11,000 annually into the futurePerson 2: (really high ability): The same $10,000 investment boosts future income by $15,000 annuallyQuestion: How does discounting affect optimal investment in education?93/29/2020In studies of twins, presumably holding ability constant, valid estimates of rate of return to schooling can be estimated.Estimates range from 3% to 15% annual return to a year of education.Generally, the rate of return to schooling is higher for workers who were born in states with well-funded education systems .Some Evidence103/29/2020School Quality and the Rate of Return to SchoolingSource: David Card and Alan B. Krueger, “Does School Quality Matter? Returns to Education and the Characteristics of Public Schools in the United States,” Journal of Political Economy 100 (February 1992), Tables 1 and 2. The data in the graphs refer to the rate of return to school and the school quality variables for the cohort of persons born in 1920-1929. 113/29/2020What are the Implications?The amount of education individuals will get depends on Factors affecting their current and future earningsIndividuals whose earnings are substantially boosted by education are more likely to get more education than those where the effect is smaller (educational ability)Age-earnings profile: lifetime earnings under different scenariosTheir own individual interest (discount) rateHigher interest rates will reduce investments in future earnings. Time preferences: how a person feels about giving up today’s consumption in return for future rewards.123/29/2020Investments in Training3/29/202013On-The-Job TrainingMost workers augment their human capital stock through on-the-job training (OJT) after completing education investments.Two types of OJT:General: training that is useful at all firms once it is acquired.Specific: training that is useful only at the firm where it is acquired.143/29/2020Who Pays for General Training?Consider first general human capital (GHC)increase in skills  employee can earn more elsewhere  difficult for employer to capture return on investmentabsent other considerations, worker should pay for GHCpay ≈ productivityturnover has no cost to the employee or employerFirms usually should “charge” employees, via lower pay during trainingthis kind of implicit arrangement is common for new employees, esp. those with little experiencewhy instead of school? Many skills are best learned on the job153/29/2020Should Employers Pay for MBAs?Many firms offer some GHC training to employees. Why?firm may be efficient trainer (in effect selling @ low cost to employee)economies of scale; practical skills more easily learned in a work settingemployees may pay implicitly, through lower paytax arbitragefor low levels of training, firm may recoup costsnot all employees are at the margin of quittingcountries with wage compressionemployee may not get high returns to skills; firm may earn ROI insteade.g.? German apprentice systemeducation or training benefits may improve recruiting self selectionskills & returns on training investments are complementaryfirm may obtain better info. than outside market about employee skillsdevelop employee targeted for future leadership role163/29/2020Who Pays for Firm-Specific Training?FSHC is more complicated after training productivity = K2 at this firm, but only H elsewherefirm & employee have incentive to stay together after training, unlike w/ GHCIf one side pays for training, hoping to earn the ROI later, it risks a “Hold-Up” problem from the other sideHow to resolve?split investments & returnscan work w/ adequate trust / reputationfirm can invest in reputation as fair & reliable employernow how the employer-employee relationship becomes more complex 17K2K1TrainingPost-trainingHTimet*3/29/2020Employee Non-Compete AgreementsOne way to reduce risk of employee Hold-Upoften difficult to enforce in courtlegal system balances firm’s interest in protecting assets, against employee’s liberty in choosing employmentPossible clausesrequire adequate notice before leavingrequire to describe new employer, job dutiesrequire to train successor; introduce to clientsprohibit from recruiting colleagues to leave as welltie vesting to non-compete performance after leavingRestricting outside options imposes a cost on employeecompensate through higher salary or signing bonus when making offerif non-compete signed after employment starts, compensate w/ lump sumalso helps legal enforceability183/29/2020Returns to Human CapitalThree important properties of age-earnings profiles:More educated workers earn more than less educated workers.Earnings rise over time at a decreasing rate.The age-earnings profiles of different-level education cohorts diverge over time (they “fan-out”).Earnings increase faster for more educated workers.193/29/2020Firms and Training203/29/2020Specific TrainingTraining is only useful to that firmIdentical to problem of investing machineryInvest in specific training in order to improve productivity and increase the future income of the firmSpecific training involves costs Both direct costs and forgone income during the training periodFirm will invest in specific training so long as the PDV(increased output) > PDC(costs)Period over which return is realized must do better than pay back for lost output during training.213/29/2020Firm Specific TrainingTime with FirmwHS-HDollarsPost Training ProductivityCurrent Productivity0Training Period223/29/2020Specific Training and PayWhen training is firm-specific and cannot be used outside of the firmEmployees cannot obtain higher pay at another firm because of their trainingThere is no extra inducement to leave the firmHowever, firms will lose the value of the training if the employee leaves the firm due to natural turnoverThe firm may share the improved productivity to induce the employee to stay 233/29/2020Firm Specific Training – Productivity SharingTime with FirmwHS-HDollarsPost Training ProductivityCurrent Productivity= Market Wage 0Training Period243/29/2020General TrainingGeneral Training can be useful to other firms once it is acquiredThe Firm’s problem:Firm pays for general training, realizes improved productivityFirm needs to recapture its training costsCannot pay employee full value of improved productivityAnother firm can offer the employee a higher wage and save the training costsWage =Marginal ProductPoaching makes providing general training unprofitable253/29/2020General Training and the Recapture ProblemTime with FirmwHS-HDollarsPost Training Productivity=Market Wage0Training PeriodWage Needed to Recover costs263/29/2020Where does this problem ExistConstructionReady movement of employees between firmsLimited training outside of the union sectorIncomplete and uncertified trainingTruckingFirms are unwilling to provide general training to drivers (all training in truck driving is general)BankingMHRLR?273/29/2020SolutionsHave employee pay for general trainingEmployee takes reduced pay during training period and goes to full pay when training is completedFirm “loans” employee cost of general trainingPaid back over time through reduced wageIf employee leaves, must pay back full value of loan immediatelyUsed by trucking firms, limited by state lawSet up a shared training system between firmsJoint labor management apprenticeships in construction283/29/2020Recapturing the Costs of General TrainingTime with FirmwHS-HDollarsPost Training Productivity=Market Wage0Training PeriodWage Needed to Recover costs293/29/2020Policy Solutions (cont’d)Firm and employee have a long term relationshipEmployee doesn’t intend to leave the firmBack loaded pension systemSystem of advancing through the firm over timeAn interesting questionCapelli finds that firms overall have greatly reduced investments in training Long term employee/employer relationships are also on the declineIs this chance, or economics at work?303/29/2020Rent Sharing and Compensation3/29/202031Intellectual Property: PartnershipsIP raises similar issues: suppose a key employee develops new technology for your firmlike GHC, the employee might take (some of) its value if they quitbecause of imperfect patent protectionlike FSHC, the employee used firm resources to develop the technologyPartnerships arise because of important shared investmentsmust pay key employees much of the value they create, or they will quitif they quit, at best you lose benefits of the shared investment. At worst, they will compete against youa solution? Partnership also creates good incentives to invest, etc.alternative solution? Next slide323/29/2020RECAP – Chapter 3Firms should pay for training when it is specific they are assured that the employee will remain long enough to recoup costsEmployees and firms estimate the value of training similarly, but their parameters differThe Age-Earnings is key to many analyses – it’s U-shaped and considers alternative wage Firm stability affects employees’ willingness to invest in firm-specific training 333/29/2020