When private sector firms provide skills for adults, most do so through on-the-job training (OJT). However, under what conditions can private sector firms provide more OJT? Investigating this question is critical to help governments leverage scarce domestic resources for public investments, and to support, vulnerable groups, while enabling the private sector to take on the bulk of adult skills training provision.
According to a background paper for the World Development Report on Education, firms that provide OJT do so when it is critical to their productivity — and when productivity is critical to their survival. Based on a literature review of 200 peer-reviewed papers, the appropriate role of government should be to correct for market failures that stand in the way of firms and workers (fully) internalizing the costs and benefits from OJT – rather than crowding out their activities. Instead of supplying skills for all, policies should focus on raising competition for firms. In more competitive environments, firm need to continue to invest in building human capital to defend (and grow) their market share. However, interventions to create more competitive product markets are not a panacea. Indeed, OJT provision can tend to be exclusionary, for example, for specific groups (older, less educated, women workers) who receive lesser training. Financing skills development for groups that are at a risk of being excluded is an area that calls for more direct forms of government intervention.
Productivity: How much do private sector firms benefit from OJT provision? What are the returns from OJT to wages and productivity at the firm level?
Historically, much of the literature has focused on the link between OJT and rises in wages - rather than productivity - due to data challenges (see here for Kenya and Zambia, and here for Mexico). However, some carefully designed studies that treat for selection issues suggest that OJT is linked to both wage and productivity gains, with firms benefiting more than workers (see here, here and here). The internal rate of return analysis for developed countries, where the data exists, finds the returns to be between 0 to positive, indicating that OJT is a profitable investment strategy for firms.
The evidence points to three results about OJT: (i) productivity gains outweigh wage gains, indicating that firms benefit more than workers, and that workers are willing to bear some cost for the training (possible explanation: workers may move to a different firm in the future and firms cannot effectively stop this from happening); (ii) future employers are willing to pay a wage premium for previously trained workers (possible explanation: some of the skill content of training is transferable and future employers can hit the ground sooner by hiring trained workers); and (iii) based on wage gain data, the transferability of skills is higher within the same sector than across sectors.
Survival: Although OJT increases firm productivity, firms underprovide it. Under what conditions will firms optimally invest in OJT?
Firms that function/compete in high-productivity environments tend to provide more OJT. More competitive product markets push poorly performing firms out and raise the stakes for existing firms that could capture greater market share were they to increase investment in new practices or lower costs. As markets open, more demanding standards will require higher human capital levels. For example, in Argentina, exporters tend to become more skill intensive in both production and non-production occupations, whereas in India, firms exposed to greater competition, such as auto-parts manufacturers, invest in their own OJT programs. For such firms, investing in OJT became an urgent, survival activity.
Problems at the management level can also contribute to low OJT demand. A robust body of evidence exists about information failures within firm management. These can be both caused by and lead to limited managerial time, limited autonomy, misinformed cost-benefit comparisons with low-quality local competitors leading, in turn, to a “we are ok” mindset and misaligned incentives. A study from Pakistan illuminates this point: Despite being introduced to a low-cost technology which improved product quality and firm profitability, the management team did not encourage workers to retrain due to poorly-designed human resource (HR) policies. In competitive markets, managers are more fearful of losing their jobs. Firm owners are more likely to select competent CEOs (ideally a non-family member) and institute performance-based HR policies to attract and retain talent. These issues can be addressed directly – through business consulting services - at the firm level or by improving product market competition to improve management quality.
What does this mean for policymakers who would like to see more private sector provision of OJT across industries?
First, the public sector needs to communicate, partner with and improve its understanding of firm-level challenges. This would require bolstering the capacity of public institutions that work with the private sector to include personnel who can effectively engage with the private sector, and vice versa. Second, instead of giving funds to firms that tend to crowd out private sector funding, policy reforms to increase OJT demand would need to consider: (i) encouraging product market reforms to increase competition; (ii) reducing the existing information asymmetries regarding new technologies, firm needs and new certifications; (iii) increasing managerial capabilities through business consulting services; and (iv) aligning worker and firm incentives through better designed HR policies. This could free up important space in limited public budgets for education, and reallocate more funds to improve skills service delivery for vulnerable adult groups, and quality of early childhood education, teacher training or foundational skills in basic education.
In summary, encouraging private sector participation in skill provision might have more to do with the competitiveness of the sector (and the firm) where the skills will be utilized than previously imagined. Before approving public investments in skills development, it is critical to ask: What is the competitive nature of the sector? What is preventing the sector from investing in OJT? What other constraints are firms facing that prevents them from investing in OJT? Will there be an equitable provision for specific worker groups or will gaps be amplified? For governments, it is important to address the various market challenges that firms face in encouraging greater OJT provision, while leveraging public funds to directly address equity issues.