Economics of Education:

Economics of On-the-job-
training
AISHNA SHARMA
02.11.2018, 5.11.2018
SME, SNU
Introduction

 Human Capital is formed not only in educational institutions

but also within the firms- through training.
 Productivity is affected by the job itself.
 Individuals learn new skills and perfect old ones while on
the job.
On-the-job training

 Future productivity can be improved only at a cost.

Otherwise, there would be an unlimited demand for
training.
 What is the cost of training?
 Time and effort of trainees
 Teaching provided by others
 Equipment and materials used
 These could have been used to produce the current output if
they had not been used in raising future output.
Decision of a profit maximizing
firm without on-the-job training
 Assumption- Labour and Product Market are Perfectly
Competitive.
 In the equilibrium a profit maximizing firm would be in
equilibrium (in hiring) when marginal receipts from labour
would be equal to marginal expenditure on labour.
 MP=W, where W equals wages or expenditures and MP
equals the marginal product or receipts.
 Firms are not concerned about the future.
Decision with on-the-job
training
 The previous conditions change when on-the-job training is
taken into consideration
 In case of on-the-job training a connection is created between
present and future receipts and expenditures.
 Expenditure during each period need not be equal wages,
receipts need not equal the maximum possible marginal
productivity, and expenditures and receipts during all periods
will be interrelated.
 Training might lower current receipts and raise current
expenditures, yet firms could profitably provide this training if
future receipts were sufficiently raised or future expenditures
sufficiently lowered.
 If training were given only during the initial period, expenditures during the
initial period would equal wages plus the outlay on training, expenditures
during other periods would equal wages alone, and receipts during all
periods would equal marginal products. This can be written as

 Where k is the outlay on training

General form of equation

 If a new term is defined, G (net benefit to the firm from training)- returns that a firm receives from
training

 Therefore, MPo+G=Wo + k
 Since the term k measures only the actual outlay on training it does not entirely training costs- it
excludes the time that a person spends on this training, the time that could have been used to produce
current output. The difference between what could have been produced MPO΄ and what is produced
MPo is the opportunity cost of the time spent in training. If C is defined as the sum of the
opportunity costs and outlays on training, the previous equilbirum equation becomes

 G and C will measure the return and the cost from training
Types of Training

 General Training:
 General Skills are imparted. These skills are portable; these
have value to other employers.
 Specific Training:
 Imparts specific skills. These skills are useful only at the
incumbent firms. Not portable.
General Training

 General training: improves the productivity of the employee

and is useful in many firms besides those providing it.
Raises the productivity of the worker equally in all the
firms. Since marginal producitivity rises equally, and Since
it is a competitive market, w=MP in all firms (The firms
could capture some of the return from training only if
MP>w. But not possible,
General Training

 Since it does not bring any return why does a firm in labour
market provides training?
 It will provide training only when it did not have to pay any of
the costs. Person receiving training would be willing to pay
this cost as this raises their future productivity.
The implications can be formally expressed in terms of equations:
Since MP=W in each time period after training,
G=0. Therefore, we have
General Training

 In terms of actual marginal product,

MPo =Wo + k
Or Wo= MPo – k
The wages of trainees would not equal their opportunity
marginal product but would be less by the total cost of
training.


Relation of earnings to age

 Training has an important effect on the relation between

earnings and age.
 Suppose untrained person received the same earnings
regardless of age, as shown by horizontal line UU.
Specific Training

 Some kinds of training raise the productivity differently in

the firm providing it and other firms.
 Training that raises productivity more in the firm providing
it is called as specific training.
 Has no effect on productivity of trainees that would be
useful in other firms
 For example, a fighter pilot is useful only in defense sector
and not elsewhere.
Specific Training

 Resources are spent in familiarizing new employees with

their organization and the knowledge thus acquired is a
specific training.
 Effect of investment in employees on their productivity
elsewhere depends on market conditions as well as the
nature of investment. Within specific training there exists a
large variety
 Very strong monopsonists might be insulated from
competition
 Firm in a competitive labour market would face a constant
threat of raiding.
 Specific Training

 If all the training were specific, the wage that an employee would get would be
independent of the wage they would get elsewhere (their productivity
enhancement is of no use else where). Therefore, the wage paid by the firms
would be independent of training. The training does not benefit the employee
in moving outside the incumbent firm and therefore they would not be willing
to pay. The firm therefore has to incur the cost. Firm would collect the return
in the form of larger profits resulting from higher productivity. Training would
be provided as long as returns are larger than the costs. Long run equilibrium
requires returns to be equal to the cost.
Specific Training

 The equilibrium can be written as

Where C is the cost of training given at the initial period, MP΄o

is the opportunity marginal product of the trainees(Marginal
Product elsewhere), Wo is the wage paid to trainees (wage
elsewhere) and Wt and MPt are the wages and Marginal
Product in the period t. G=C, as wages elsewhere are equal
to marginal product elsewhere. Return from training equals
the cost
Specific Training
 This follows from the assumption that firm pays all the costs and
gets all the returns.
 But one could argue that workers should pay all the costs as they get
higher returns in the future such that their wage is equal to their MP?
That is Wt=MPt. Therefore, w= MP΄o –C, just like general training.
 Who pays for specific training?
 1. If firm pays, and the worker quits for another job that would lead
to a huge loss of the firm; its expenditure gets wasted.
 2. If a worker pays and after training they get fired, that would lead
to their loss of expenditure, because they would not be able to collect
any return on their investment, elsewhere.
 The willingness to pay would depend upon the likelihood of turnover
Specific Training
 In case of a competitive market labour turnover is not a problem because one can be
replaced by the other.
 But if firm pays, and an employee quits, then a new employee would again need to be
trained otherwise the MP of the new employee would remain less than that of previous
one and firm would not gain as much as they were earlier.
 Firm should take turnover into account.
 If there is a turnover, then they can bank on the remaining. But the returns to the firm from the
remaining has to be large enough to cover the loss due to turnover.
 Likelihood of turnover is negatively related to the level of wages. Firm can increase the wages to
retain employees. But that would increase the supply, putting again a downward pressure on the
wages. This would require rationing.
 The final step could be to shift some costs of training to the trainees. This would bring supply
more in line with demand. Since firms no longer pay all the costs, they must also part with the
returns. Thus the trainees pay some costs and share some benefits
Specific Training

 Generally, a specific training is not entirely specific. It has

some component which is generic in nature and some is
specific.
 The fraction of the costs paid by the firms would be
inversely related to the importance of the general component
or positively related to the specificity of training.
 Our conclusions can be stated more generally in the form of
equations developed earlier.
MP΄ + G= W+C
If G΄ measures the return collected by employees, the total
return G΄΄ = G+ G΄. In equilibrium total return G΄΄=C.
Specific Training

 Let a represent the fraction of the total return collected by

firms. G=aG΄΄ and G΄΄=C,
 MP΄ + a C= W+C
W= MP΄-(1-a)C
Employees pay the same fraction of costs, 1-a, as they collect
in returns
Implications of Specific
Training
One might think that wages would be higher for general training than
specific training because of greater possibility of mobility in the
former. But turnover is a greater problem in specific training because
in general training firm does not pay the cost of training. To retain the
employees with specific training, they are offered a higher wage than
people with specific training.
Also the employees with specific training have a less incentive to quit
and firm also have a less incentive to fire them as compared to people
with general training or no training. This implies that layoffs and
turnover are negatively correlated with the amount of specific training.
Turnover should be least with extremely specific training and most for
those receiving general training.