41318 World Bank Employment Policy Primer September 2007 No. 8 IF ON-THE-JOB TRAINING IS SO IMPORTANT TO COMPETITIVENESS, WHY ISN'T THERE A BETTER MARKET FOR IT?* There is no question that up-to-date job skills are Why Workers Skills Upgrading is critical to economic performance in today's rapidly Important for Growth changing and fiercely competitive global marketplace. Paradoxically, while the economic efficiency and inno- While there is convincing evidence that training vation capacity offered by the upgrading of human cap- workers has positive effects on raising individual wages ital is widely recognized, market forces have proven and increasing labor productivity, there is little aware- inadequate for stimulating and linking the demand and ness of its critical role for economic progress. In a glob- supply for this on-the-job training. In theory, employ- al economy where market shares and profit margins are ers, who seek a qualified workforce, would create a becoming increasingly vulnerable, the capacity for rapid demand for training providers, who would compete change and innovation are crucial to a firm's survival. with one another to offer relevant training. However, the To cope with change and avoid the risk of a downward demand for training suffers when there is lack of com- spiral of low revenues and consequently low wages, petitive pressure, low profitability, or market imperfec- firms--often with a helping hand from governments-- tions, which contribute to increased likelihood of mis- try to raise labor productivity and competitiveness matches between demand and supply. To remedy low through balancing investments in technology and levels of skills upgrading and market imperfections, human capital. This was the strategy followed by the partnerships between the public and private sectors in Asian tigers, Malaysia, Mauritius, and Ireland, and it has many industrial and developing countries alike have proven worthwhile. been formed to boost both competitiveness and employ- Empirical data on the relationships among techno- ment. Yet these partnerships have often failed to adjust logical change, innovation, and human capital highlight supply and demand of training. the complementary nature of workforce education, job- This note offers lessons from both the failures and specific skill upgrading, technological advancement, and successes of these partnerships in the interest of boost- trade openness. The newly assembled firm-level data of ing economic growth through raising the training levels the Enterprise Investment Climate Surveys (EICS) with in the workplace. 54,325 firms in 82 countries corroborate earlier findings *This note was prepared by Reyes Aterido based on references and own estimations. The author would like to thank Carmen Pagés, Rita Almeida, Mary Hallward-Driemeier and Hong Tan for helpful comments. The World Bank Employment Policy Primer aims to provide a comprehensive, up-to-date resource on labor market policy issues. The series includes two products: short notes, such as this one, with concise summaries of best practice on various topics; and longer papers with new research results or assessments of the literature and recent experience. Primer papers and notes are available on the labor markets Website at , by contacting the Social Protection Advisory Service at (202) 458-5267, or by email at . O n - t h e - J o b T r a i n i n g of various studies on the dynamics of these relation- take a wide range of forms. The International Labor ships. The surveys show that, all things equal, the greater Organization (ILO) recommends that the government the foreign capital participation, innovation, workforce assume the primary responsibility for investing in pre- education, and exports, the greater the likelihood that a employment training, and enterprises and individuals firm provides training for its workers. Availability of the responsibility for on-the-job training. Worldwide educated and skilled workers has proven critical for trends have been moving from state-led, centralized, adopting new technologies and for attracting foreign supply-driven systems towards more flexible, demand- direct investment (FDI). An oft-cited example is Intel's driven public-private partnerships that are decentralized investment of US$600 million in Costa Rica. Intel and at the local and sectoral levels. Typically, governments sixty-one other investors ranked "political stability" and focus on creating legal frameworks and financial incen- "a well-educated labor force" as the top strengths of tives to advance private sector and individual investment Costa Rica's business environment. in training. The most common include levy grant Upgrading workers' skills is not only essential for schemes (compulsory or voluntary taxes on payroll or competitiveness and innovation, but empirical evidence outcome); levy-rebate schemes, in which employers are shows that it also boosts firms' productivity levels. This partially reimbursed for approved training as in finding has been widely reported in industrialized coun- Malaysia, Nigeria, the Netherlands, and many Latin tries but also in several developing countries. Tan and American countries; levy exemption schemes where Batra (95) and Batra (1999, 2000) analyze 6 developing employers are exempt from levy payments if they spend countries1 and report that firms training their employ- a percentage (upper bounded) of their payroll in train- ees experience productivity gains between 26 and 71 ing as in France, Korea and Morocco; tax incentives for percent with respect to those not training; likewise, EICS approved training as in Chile; and also training credits, data from 39 developing countries in 5 different regions training awards, and individual training accounts. Suc- show that, all things equal, training is responsible for 20 cessful schemes in raising training investments by enter- to 70 percent increase on productivity2. prises are Singapore and Chile. The Singapore's Skills Development Fund (SDF) collects a levy based on wages Who are the Players in the Skills of low-skilled workers, which motivates employers to Upgrading Market? upgrade low-skilled workers although perhaps at the cost of hiring less low skilled labor.5 In addition, sup- It is not only firms that reap the benefits of skills ports approved training programs linked to economic training; individuals and governments do as well. For restructuring and knowledge-intensive industries. This the individual, having up-to-date knowledge and skills provides flexibility to adjust to economic conditions. facilitates integration into the workforce as well as pro- The scheme followed by Chile relies on a direct credit to fessional development and wage advancement. For gov- firms, up to a certain limit, to be used on training, or ernments, skills upgrading is not only associated with higher economic growth and income levels, but is also a tool for increasing social gains through raising employ- 1 ment, expanding the formal sector, and improving social The productivity effect of training is estimated using a production function and an instrumental variable approach to correct for selec- equity.3 In recognition of the economic and social tivity bias due to the endogenous nature of firm's decision to train importance of training, most countries have created and the production function. Although the methodology allows national training systems4 (VET) to meet these social establishing causality in the direction of training impacting pro- ductivity, endogeneity issues are difficult to resolve with certainty and economic objectives by fostering human capital empirically. development tailored to the labor markets' needs. In 2Author calculations using an unrestricted production function and many countries, public and private sectors--and, to a an instrumental variable approach 3 lesser extent, unions and NGOs--have formed partner- There is substantial support for this claim in academic literature. See Almeida and Carneiro 2006. ships in sharing the responsibility for the management, 4The training system is typically referred to as the Vocational Edu- financing, and provision of these systems. The allocation cation and Training system (VET). of these responsibilities among these various players can 5No evidence was found in this regard 2 O n - t h e - J o b T r a i n i n g firms would have to pay taxes otherwise. Chile's success a generally low incidence and weak market. The factors was due to the decentralization of management--cor- that determine the demand for training are: porations were able to manage public vocational schools introducing flexible curriculums and matching labor 1) labor market dynamics: employment and labor markets needs; to the removing of entry barriers to new force growth determine levels of unemployment, providers; and to the effective allocation of tax credits which spurs individuals and governments to which covered not only the cost of training but also enhance employability; salaries of trainees and contributions to training 2) the dynamics of the economy: private sector schools. By contrast, the Brazilian and Nicaraguan tax competitiveness, technological change, and open- rebates schemes have been less effective due mostly to ness to external markets increase the need for lack of consistency, inefficiency, complicated procedures upgrading skills; and information failures. 3) the level of education: education and skills upgrading are complementary; 4) the cost-effectiveness of training: benefits of training should outweigh costs. In theory, employers in a competitive environment would seek a qualified workforce to adapt to the change in technology and would create a demand for training providers. If the demand is sufficient, training providers compete with one another to offer relevant training and would raise the confidence of employers in the training supply. In this way they would stimulate private sector technological advancement that would require more and more upgrading skills in a virtuous circle. Simulta- neously, comprehensive and widely disseminated infor- mation on content, cost, and accredited quality of cours- es play an important role in enhancing suppliers' A Look at the Training Market competitiveness and enterprises' inclination to train. Imperfections and Possible Solutions However, the demand for training suffers when there is lack of competitive pressure, low profitability, The firm-level EICS data show that only 25 out of 82 or market imperfections. In developing countries where developing countries have 50 percent or more firms pro- educational attainment is generally low and the indus- viding training. Many of which are the result of govern- try is labor-intensive with the use of mature technolo- ment-subsidized programs to boost training. These gov- gies, the demand for training is typically weak. In addi- ernment-led programs may or may-not induce a tion, market failures contribute to increase likelihood of market-driven training. The training market is especial- mismatches between demand and supply. Market ly weak in small, domestically owned, non-innovating, imperfections include weak supply (irrelevant or/and and non-exporting firms, and for unskilled workers. The poor quality), financial market malfunctions, and poor surveys reveal that firms that provide training to their information as to what is being offered and its benefits. employees rely more on sources that are internal or pub- In addition, worker training suffers from externalities lic rather than external or private, and that the likeli- because the risk of workers' turnover increases with hood of training is higher among the more technology- skills upgrading and employers are reluctant to invest in intensive sectors, such as electronics and metals. a volatile asset. Data from EICS in 8 developing coun- Given the wide-range benefits of on-the-job train- tries illustrate the different degree of relevance of these ing, it is necessary to explore the underlying reasons for market weaknesses and imperfections. The most popu- 3 O n - t h e - J o b T r a i n i n g lar reason why firms do not train is because workers tivity, the public training does not have any impact at all learn by doing--this reason points towards too possibly on labor productivity.6 If public training does not pro- little innovation and extensive use of mature technolo- vide productivity gains to the employer, why do firms gies; second, training courses lack relevance--this indi- rely on public providers for training? This result suggests cates little competitiveness and failures on the supply that firms using public training may have been motivat- side; third, training is not affordable--this could be ed by government schemes and by the recovery of a for- caused by low profitability and possibly failures in the gone fee rather than by seeking economic gains. financial markets; and lastly, labor turnover (as exter- But, is the market capable of a sustainable on-the- nalities generated by the training market). The fact that job training system? A joint study of the World Bank firms list irrelevance of training as a reason for not and the International Labor Organization (Gill et al. offering training shows the tendency of the market to 2000), on worldwide VET systems, supports the capa- be supply-driven. When government intervention bility of a sustainable market for training and illustrates includes a mandatory enterprise fee such as a levy to VET systems and solutions to effective public-private promote demand for training, firms are inclined to partnerships. The study examines nineteen countries train for the sake of recovering the fee. If the quality of belonging to transition, high-growth, low-growth, and the training offered is poor, it is likely that returns are industrial economies that have implemented reforms of low, and the demand for training will be weakened as a their VET systems. It argues, against conventional result. The data in the figure above showing that there is belief, that with the appropriate legal framework, the greater incidence of training for larger firms, in-house market is capable to provide training for sectors with versus outside providers, and from public versus private higher training costs. It illustrates this point with the sources, suggest that government incentives maybe fail- experience of the Czech Republic where private suppli- ing to stimulate a sustainable training market and to ers of technical training rose as a consequence of the motivate small firms or sectors with higher training industrial growth. They examine the case of Australia, costs. There is also a potential that incentives maybe which provides inspiration of a successful public-pri- favoring opportunistic behavior on the part of suppliers vate sustainable system, capable of cost-effective and powerful firms. A piece of evidence supporting this responses to the labor market conditions. Australia's is the case of Nicaragua. In Nicaragua the government main components of success and potential guidelines to collects 2% of levy on payroll, which is controlled by a implement in other countries are: public provider of training. The overall results of the management of the funds appear disappointing to Linking education and labor markets: they (1) companies which complaint that they receive little ben- established a single agency (ANTA) for educa- efits from the public training system (only 27 percent of tion, training and employment; (2) included a firms provide training.) In fact, large firms that only tripartite authority with private sector and represent 16 percent of urban employment and 0.02 unions in the VET management system; and (3) percent of firms in urban areas, receive 60 percent of introduced financial mechanisms that supported government training resources for the private sector, the central role of employers, who determined while small firms receive only 11 percent of the work-specific training acquired in the workplace resources. while costs were redistributed towards federal A sample of 13 developing countries from EICS data and state governments and users. illustrates an aspect of the distortions of a supply-driven ANTA introduced new accreditation procedures market. Comparing the percentage of public and private for training courses with competency standards training provided, and their impact on labor productiv- on an industry-by-industry basis. Training stan- ity, the data shows that, on the one hand, 8 of these dards allowed participants enhance their mar- countries rely more on public training schools than on ketability and to move from traditional education private providers as source of external training. On the other hand, while the larger the percentage of private training the larger the positive impact on labor produc- 6Author calculations using an instrumental variable approach 4 O n - t h e - J o b T r a i n i n g to VET system and vice verse. The industry was 5) the management organism within the system the main force behind setting standards, assess- should be free of any conflicting interest; for this ment of procedures, and accreditation. it is advisable to separate the strategy or political States only financed the called "core" activities in body, the accreditation system, and the public the VET. A training wage was calculated by an provision; agency based on productive work with a topping 6) to ensure a sustainable market, it is important by the government if it resulted too low (it shift- allowing for cost-sharing between all benefiting ed a large part of the cost of training away from parties--including workers; employers). Costs were allocated to foster judg- 7) there should be a good information system, capa- ment on the part of the buyer. ble of raising the awareness about the benefits of Market System: a shift from VET benefiting sup- skills-upgrading and evaluation of the impact of pliers to buyers. Funds for retraining the unem- training. ployed included private providers subject to a bidding process. References Conclusions Almeida, Rita and Pedro Carneiro. 2006. "The Return to Firm Investment in Human Capital" World Bank Policy Research Working Paper 3851, February 2006. This Note on training is based on firm-level analyses Batra, Geeta. 1999. "Skills Upgrading and Competitiveness in from a large cross-country sample and on case studies. It Guatemala." World Bank, Private Sector Advisory Ser- shows evidence on the complementarities between on- vices, Washington, D.C. ___. 2000. "Private Sector Training and Competitiveness in the-job training and education, openness, and foreign Nicaragua." World Bank, Private Sector Advisory Ser- investment. It also shows how training plays a substan- vices, Washington, D.C. tial role in the enhancement of productivity and compe- Gill, Indermit S., Fred Fluitman, and Amit Dar. 2000. Match- tition. It argues that partnerships between governments ing Skills to Markets and Budgets. International Labor Organization. World Employment Report and the private sector have not been all that successful in 1998­1999. providing necessary conditions for a sustainable training International Labor Organization. 2003. "Learning and Train- market, which would improve individuals' employabili- ing for Work in the Knowledge Society." Larrain B., Felipe, Luis F. Lopez-Calva, and Andres Rodriguez- ty and wages, private sector ability to compete, and Clare. 2000."Intel: A Case Study of Foreign Direct Invest- country's economic growth. Following reviewed case ment in Central America." Center for International studies, recommended basic principles for government Development: Harvard University. intervention to raise the incidence of training are: Tan, Hong, and Geeta Batra. 1995. "Enterprise Training in Developing Countries." Washington, D.C.: World Bank. World Bank, Private Sector Advisory Services. 2004. "Reform 1) incentives and subsidies should respond to a well of Labor Skills Training to Strengthen Competitiveness of targeted strategy where results can be measured the Nicaraguan Private Sector." Washington, D.C. and adjustable; 2) private sector should have a strong role in shap- ing the strategies of the training system and in ensuring pivotal links to the labor markets; 3) competition in the delivery and participation of private suppliers should be favored; 4) the resulting system should include in its govern- ing body all the main parties, ensuring that they have an effective voice, and that the system pro- vides a unified front capable of building trust; The findings, interpretations, and conclusions expressed herein are those of the author(s), and do not necessarily reflect the views of the International Bank for Reconstruction and Development / The World Bank and its affiliated organizations, or those of the Executive Directors of The World Bank or the governments they represent. 5