On the Job Training

1. On the Job Training

2. Weekly earnings College grad Some college High school grad High school drop out age

3. On the previous slide we see information on weekly earnings. At a certain date a survey was done and folks told their age, education level and weekly earnings. What we see is 1) More education means higher weekly earnings, 2) As workers age earnings rise, but at a decreasing rate, and 3) Those with more education tend to get higher increases in earnings – in other words the lines in the graph diverge. In a previous section we studied the schooling decision and saw there that schooling can lead to differences in earnings. Here we study on the job training and how that can contribute to differences in earnings.

4. In the Human Capital model we studied the decision that individuals make concerning how much education to take. We saw that from an ECONOMIC POINT OF VIEW, individuals take more education, and thus enhance their human capital, so long as the net present value of the education choice is positive. Here is a quick story to remember the general results of that story (really a theory). When you graduate from high school you can go to college and incur costs now in the hope of attaining higher income than without the college. The additional income has to be enough to overcome the expense of college for the individual to actually go to college. Now we want to study another human capital enhancer – on the job training.

5. On the job training • On the job training comes in two varieties: • General training • Firm specific training. • General training refers to training that enhances a person’s productivity in many firms. Firm specific training enhances a person’s productivity only at the firm that provides the training. • Examples: • General – learning to use basic Window’s software, perhaps, • Specific – learning to use firm based solution software.

6. The training decision earnings Training earnings profile B No training earnings profile A experience

7. On the previous slide we see a horizontal line that represents the earnings over the working life of a person who does not take job training. We also see an s type sort of looking curvular shaped line that represents the earnings over the working life of a person who actually takes training. Why is the training line lower at the beginning? Presumably the earning is lower during the training period and then after training the earning increases. You have heard of the phenomenon of a training period, have you not? Area A in the graph on the previous screen thus represents the cost of the training to the worker in the form of lower earnings during the training period. Area B is then the enhanced earnings over the rest of the working life.

8. If the present value of B > present value of A then the individual will “accept” the training by taking a job that would require it. Otherwise the individual would not take a job that required training.

9. Does everyone take training? Explain using this graph. (this is NOT an assignment at this time.) earnings No training earnings profile Training earnings profile experience

10. We will consider a model where the relationship between a worker and a firm lasts two periods. The total labor costs to the firm each period are TC1 and TC2. The contribution the worker makes each period, the value of the marginal product, is VMP1 and VMP2. Earlier this term we saw the profit maximizing firm demands labor up to the point where the wage equals the value of the marginal product. When we include more costs than just the wage and we consider more than one time period, then the profit maximizing firm will want labor up to the point where TC1 + [TC2/(1+r)] = VMP1 + [VMP2/(1+r)].

11. Now, say on the job training (OJT) occurs in the first period and costs H dollars. Plus in the first period the worker gets paid w1. No training occurs in the second period and the worker gets paid w2. So TC1 = w1 + h and TC2 = w2 and our profit maximizing firms employment decision becomes w1 + H + [w2/(1+r)] = VMP1 + [VMP2/(1+r)]. General Training Remember general training is training that can be used at any firm. If a firm provides training in the first period then the workers VMP in the second period for that firm and all other firms is enhanced. Since other firms would try to entice the worker away from the firm in the second period if the firm did not pay a wage equal to VMP in that period, we see w2 = VMP2.

12. When w2 = VMP2, w1 + H + [w2/(1+r)] = VMP1 + [VMP2/(1+r)] becomes w1 + H = VMP1 and we can see w1 = VMP1 - H. The wage the worker gets in the first period is less than the value of the marginal product by the amount of the general training cost. Firms will offer general training only if the worker pays for it in the form of a lower wage.

13. Specific Training If a worker leaves a firm where specific training has occurred the worker’s alternative wage would return to their pretraining productivity. What if the firm pays for the training in the first period and makes w1 = VMP1? The firm would be making an investment and would hope that with the VMP2 enhanced by the training it could pay w2 < VMPS and recover its investment. But the firm might feel queasy about this because maybe the worker will quit before the second period and the firm will be out the investment. What if the worker pays for the training? The worker would get a lower wage in the first period in the hopes of getting paid more in the second period. But if the worker is not assured the firm will keep them in the second period, then they would lose

14. out in the second period and have to go work somewhere else where they would not benefit from their training – and get just wage wbar. Their investment would not pan out. With the second period commitment unsure on both sides, it seems a compromise would be that the worker would be likely to stay if more than wbar is paid in the second period and the firm would likely want to keep the worker if they could pay less than the VMP in the second period. This suggests w2 would be greater than wbar, but less than VMP2 – and thus both the worker and the firm pay for the training. They share the cost and the gain.

15. The Mincer Earnings Function Some guy named Mincer (he was a wordy fellow) did some statistical work and combined the schooling model and the OJT concepts to have a function for wage rates in the following form: log w = as + bt – ct2 + other variables, Where w = wage rate, s = years of schooling, t = years of labor market experience and a, b and c are estimated by a statistical procedure.

16. Just wanted you to see how at each wage what the log wage looks like.

17. The value a when estimated would tell us how much the log w would increase when schooling increases by 1 year. b and c together are an indication of how log w changes when experience goes up 1 year – and it is a proxy for OJT.