Chapter Study Outline

6.1 Overview

  • On-the-job (OJT) training is an investment that a worker undertakes
    • (a) during normal working hours or
    • (b) outside of working yours but paid for at least in part by the employer.
      • Learning by doing (LBD)
      • On- vs. off-the-job training
      • Formal vs. informal training
    • General training raises a given worker’s productivity equally at all firms.
    • Specific training has no effect on the productivity of trainees that is useful in other firms
  • Rosen (1972) posited that all firms sell at least two products.
    • One is a good or service sold to consumers.
    • The other is the production education sold directly to its employees.
      • The employee’s earnings are reduced by the value of the learning that he acquires on the job.
      • Dead-end jobs that provide no opportunity to learn are expected to offer a higher wage to compensate for their lack of learning opportunities.
  • Some skills are industry-specific as opposed firm-specific.
  • Training investments in the United States are very high, with $50 billion spent on formal training in 2006.
    • Evidence suggests that OJT increases with education, experience, and ability.
    • Some findings also indicate that employers are race and gender blind with respect to formal training, but may discriminate in the provision of informal training.

6.2 The Theory of General and Specific Training

  • Based on Becker’s (1962) principles of OJT training
  • Incumbent: the firm at which the workers are currently employed
    • General skills are useful at the incumbent firm and at most other firms in the industry.
      • They are portable, hat is, they have value to other employers.
    • Specific skills are only useful at the incumbent firm.
      • They are not portable.
  • Spot market: a competitive labor market that operates within a single given time period. Spot-market employers are eager and willing to take workers from the incumbent firm.
    • General skills will be valuable on the spot market due to their portability.
      • The firm will must increase the wage of a worker who acquires general skills in order to retain the worker.
      • Thus the firm will not pay for general skills training.
    • Specific skills are not valuable on the spot market.
      • The firm need not increase the wage of a worker who acquires specific skills.
      • Thus the firm is more likely to pay for specific skills training.
  • Model 6.1: On-the-Job Training
    • (a) There is a perfectly competitive spot market.
    • (b) There are two periods, 0 and 1, which correspond to pre- and post-training.
    • (c) Capital markets are perfectly competitive. Both firms and workers can borrow at r > 0.
      • Earnings in the second period are discounted by the interest rate.
      • w0 and w1 are the incumbent firm’s pre- and post-training wage offers.
      • v0 and v1 are the spot-market’s pre- and post-training wage offers.
  • Assumption 6.1:
    • (a) The training cost is i = F + I, where F ≥ 0 is the firm’s contribution and I ≥ 0 is the worker’s contribution.
    • (b) Each worker possesses the same baseline pre-training MRP at all of the firms in the economy, y0.
    • (c) Each worker’s post-training MRP at the incumbent firm equals y1 = (V + y0), implying $V is the value added by training.
    • V, I, and r satisfy V > (1 + r)i.
      • The surplus, $S, is given by S = V/(1 + r) - i > 0.
      • Since the surplus is positive, the investment is efficient.
      • Together the firm and worker stand to gain S from the investment.
  • If training is efficient and S = V / (1 + r) - i > 0, then training is carried out and
    • (a) The firm pays for specific human capital investments.
      • w0=v0=$y0 before training takes place.
      • w1=w0=$y0 regardless of whether the worker takes the training opportunity.
        • The wage rate is constant at both the incumbent firm and spot-market firms.
      • The worker does not stand to gain from the investment, but the firm will gain SV / (1 +r), the increase in the worker’s discounted second-period MRP.
        • In the early stages of their careers, workers are paid a wage equal to their MRP.
        • In the later stages, their wage is less than their MRP such that w0 = w1 = y0 < y0 + V.
      • The firm will cover the entire specific investment such that F = i.
        • The starting wage ($ŵ0 = y0) does not depend on $i.
    • (b) The worker pays for general human capital investments.
      • w1 = v1 = $y0 + V after training takes place.
      • The worker stands to gain $V, but the firm will gain nothing since it must pay her $V more in order to retain her.
        • The MRP of the worker’s labor increases equally at both the incumbent firm and spot-market firms.
        • The increase in the worker’s value is matched by the increase in her wage, V - (w1 - w0) = 0.
      • In theory, the firm sets F = 0 for general training, and the worker sets I = i.
        • This manifests itself as a lower starting wage, $ŵ0 = w0 - i.
      • Wages increase over the course of the worker’s career, $ŵ0 = w1.
        • In the early stages of their careers, workers are paid less than their gross MRP, since ŵ0 = y0 - i < y0.
        • After training is complete, their wage equals their MRP since w1 = y0 + V.
  • In practice, firms appear to pay for general capital investments. From the economic perspective, the worker still pays for general capital investments by accepting a lower starting wage equal to 0 = w0 - i in return for general training.
  • This model indicates that training is more valuable earlier in the worker’s life.
    • General training leads to a steep earnings tenure profile, while specific training leads to a relatively flat one.

6.3 The Specifics of Specific Human Capital

  • In the event that a worker separates from the firm after receiving specific training, the firm’s investment is destroyed.
    • Thus the firm and the worker may want to enter into contracts to share the costs and benefits of specific training.
    • In contrast, job losses lead to no destruction of the accumulated general skills per se.
    • Worker turnover provides a disincentive for firms to pay for specific investments.
  • The hold-up problem: after the firm makes specific investments in a worker, the worker may take the investments hostage by making a take-it-or-leave-it offer and threatening to quit and destroy his value, thereby appropriating the returns to investment.
    • In the hold-up problem, the firm recognizes that sunk investments are vulnerable to expropriation ex post, and the ex ante fear of this type of worker behavior can discourage the firm from making specific investments.
    • This can have a disastrous effect on training.

6.4 The OJT Model: The Evidence

  • Medoff and Abraham (1980) found evidence to contradict Becker’s basic claim that job training raises worker productivity. Their study concluded that experience has no (possibly a negative) effect on productivity.
    • This could be explained by promotions.
      • Movers: high-ability workers who are promoted from one rank to the next, leaving behind low experience workers in lower ranks
      • Stayers: low-ability workers who are not promoted, leading to greater experience in lower ranks
    • Later studies found evidence to support Becker’s assertion that job training raises worker productivity.
    • Experience has a large positive effect on earnings.
      • This is consistent with Becker’s model.
        • However, contrary to Becker’s prediction, later studies found that employers pay for general human capital investments by not reducing the initial wage.
  • Later studies also found that general training investments have a greater effect on productivity than on wages. This is inconsistent with Becker’s hypothesis that wages increase in lockstep with productivity.
  • With sound theory, high-quality data, and careful empirical work, researchers continue to test and advance these theories of labor economics.
    • Labor turnover costs in the form of destroyed investment in specific training may explain some of the wage variation between men and women, since women have shorter average tenure.
  • Temporary help supply (THS) may provide free general skills training in order to charge a wage premium to businesses and to sell valuable information on workers to employees.