Executive Summary
Skills contribute in complex ways to a firm’s productivity
There is general agreement that human capital (broadly defined) is important for economic growth. Less is known about the ways in which skills and knowledge contribute to a firm’s pursuit of efficiency, innovation, and market opportunities. This paper explores the evidence about those ways. It does not cover the impacts of other firm inputs like R&D and access to capital.
What types of skills do firms need?
Three broad categories of skills are important in the search by firms for productivity improvements.
- Entrepreneurial ability is needed to identify and respond to market and innovation opportunities.
- Managerial capability is essential to provide the leadership and organisational skills required to oversee the effectiveness of production processes.
- The technical skills of employees support the effectiveness of production processes and the adoption of new technologies.
Skills contribute to increased firm productivity in three main ways
Increasing the skill level of an individual worker can influence the productivity of firms in three principal ways:
- Higher skill levels can increase a worker’s own productivity, thereby improving the firm’s productivity. A more productive worker will complete tasks more quickly, or with higher quality, or take more responsibility.
- The higher skill level of a worker can improve firm productivity by making better use of other inputs such as capital investments or R&D activities or new technologies.
- The worker’s skill levels can affect the productivity of other workers in that firm through synergies in teams, or the productivity of other firms in an industry through knowledge spillovers in activities like R&D.
How are skills acquired?
The skills required by firms can be innate, developed in the formal education system, and extended on the job. Upskilling of the existing workforce can occur through work experience, on- and off-the-job training, and job turnover.
Entrepreneurs improve firm productivity by taking up innovations and developing market opportunities
Entrepreneurship performs a number of functions, including exploring market opportunities, risk taking, innovation, the re-allocation of resources, arbitrage, and market coordination. It typically takes two forms: breakthrough inventions by smaller entrepreneurs; and cumulative, incremental improvements by R&D in larger firms.
These forms are complementary, but require different skills. Smaller entrepreneurs need innate skills such as imagination and attitudes to risk, analytical abilities and knowledge that can be acquired, and sound judgment obtained through experience. The large firm’s R&D activity needs researchers with a mastery of extant knowledge and analytical methods.
Regulatory policies influence entrepreneurial activity,
Regulations affect the structure of payoffs that entrepreneurs face, and their impact on productivity. Pro-competitive policies allow entry by firms to explore new business opportunities, and assist resource re-allocation amongst firms. Policies affecting the costs of firms of entering or exiting, such as employment protection legislation, also influence firm dynamics. Access to finance supports firm start-ups and expansions.
Management capability is central to raising firm productivity
Managerial capability is central to removing inefficiencies and optimising firm performance. One aspect is managing production processes. Also important is the design of organisational structures that utilise technology and skill inputs effectively, and human resources management that ensure worker motivation and effort. Managers require a wide skill set, including the strategic ability to adapt to a changing environment, the organisational and supervision skills to run the business, people and communication skills, and an awareness of information management processes.
Management practices are also important
Human resource management practices can provide a coherent system of incentives that enhance the contribution of workers to firm productivity. These include individual incentive contracts, the screening of new hires for suitability, group incentive pay to encourage teamwork and effort, and the provision of training. Worker rotation increases flexibility and teamwork, while communication addresses worker concerns and locates productivity improvements.
Formal education only contributes some of the technical skills needed by firms
The skills firms seek are only partly formed within the formal education system. The earnings of individuals increase with their level of education. However, other behavioural traits and cognitive capacities, such as motivation, trustworthiness, and adaptability, seem to be equally important in explaining differences in earnings. Thus, the linkage with the education system is weaker where a significant sub-set of the skills required are formed inside the firm, or where the cognitive abilities sought are largely innate.
Skill-technology complementarities increase the relative demand for more skilled labour.
The adoption of new technologies increases the relative demand for skilled labour, by making skilled workers more productive and replacing the routine tasks of less skilled workers.
At the aggregate level, the increased supply of skilled labour allows firms to take up skill-complementary technologies, and can encourage further inventions. Even with substantial increases in the supply of skilled labour over the past two decades, the earnings premium for skills has remained high.
The entry and exit of firms allows skills and technology to be used more productively
Differences in the productivity of firms within an industry are both marked and persistent. Productivity increases as innovative firms enter, poorly run new businesses fail, and continuing firms adjust their mix of skills and technology. Resource re-allocation from less to more productive plants, and firm entry and exit, are important in aggregate multi factor productivity growth.
Plants with higher levels of firm productivity also have higher workplace skills. There is US evidence of different skill-technology matches amongst plants, giving rise to a growing dispersion of wages and productivity between plants within the same industry. This, in turn, is linked to different rates of technological adoption.
Firms adopting new technologies typically already have more skilled workforces
Obtaining the full productivity gains from technical change requires changes in workplace organisation
Obtaining the full productivity gains from technical change, especially with the diffusion of computer based technologies (ICT), appears to require substantial changes in workplace organisation. These changes include flatter management structures, more team work, and performance-related pay. Thus, changes in workplace organisation complement technical change. Organisational change may account for a larger fraction of the productivity gains than does technological change alone.
Organisational changes facilitate adjustment in the skill mix. They increase the skill levels needed for data analysis and for worker autonomy and responsibility, and reduce the demand for less skilled labour for repetitive tasks.
…involving a range of adjustment and diffusion processes
Three broad groups of factors appear to be influencing the diffusion of ICT across industries and countries:
- The regulatory environment affects the ability of firms to take advantage of opportunities, in particular product market competition, and firm entry and exit.
- Firms differ in their ability to absorb ICT, arising from the firm’s skill base and level of innovative activity, and the reorganisation of work practices.
- Large differences also persist in the costs of investing in ICT across OECD countries.
The time needed for investments in complementary learning and organisational change can lead to substantial lags between ICT capital investments and productivity growth.
Knowledge spillovers occur within and between firms
Increased individual skill levels can improve the productivity of co-workers and other firms through knowledge spillovers. The importance of these externality effects is hard to assess. Where people work, and who they work with, can contribute significantly to their productivity and wages. For instance, specialists working in teams benefit from the complementary skills of other team members.
Where there is a greater stock of shared knowledge in an industry, the individual firms will be more productive. Knowledge spillovers can arise through three specific mechanisms, namely sharing of inputs, matching, and learning. Thicker labour markets appear to be important in allowing better matches between firms and the skills required, as well as increased specialisation by workers.
There is some path dependence in decisions about technology adoption and skill investments
Nationally, firms may choose technologies conditional on the expected supply of skills in the workforce, while educational investment by individuals may be influenced by the expected availability of jobs.
The factors giving rise to low technology/skill matches are clearly important, and will influence the role for government. However, it is not clear what perpetuates low skill equilibriums over time, or hinders economies from transitioning out of them. There is evidence for the UK that persistent shortages of skilled labour may be influencing technology adoption and capital investments. However, the case for further increases in the supply of skilled workers depends on whether other factors are more critical.
A number of factors influence work-based training
A significant proportion of knowledge accumulation occurs on the job, including informal training. With ongoing technical change, continuous learning will be required to maintain the stock of skills in the existing workforce and offset skill obsolescence. Larger firms are more likely to provide on-the-job training, while higher labour turnover lowers employer incentives to invest in training. Those with few educational qualifications are likely to face more limited training opportunities in the workforce. Thus the provision of employer-funded work-based training tends to amplify the skill gap, rather than compensate for low levels of prior educational attainment.
There are failures in the supply of work-based training,
Imperfections in the market for work-based training seem likely. Contrary to the dominant view of human capital formation in the workplace, there is a good deal of evidence of extensive employer-funded general training, and of wage growth following training being much less than productivity growth. However, it is unclear how important these market imperfections are, and the extent to which they cause employers and workers to under-invest in work-based training.
… but the case for policy intervention is not clear-cut
Evidence of market failure is not a sufficient basis for government intervention. A comparative institutional analysis is warranted to assess the relative merits and effectiveness of the options. The design of any interventions depends on which types of market failure are more important. A number of co-financing arrangements are used in OECD member countries that allow employers and workers to generate more tailored training assistance packages and generate the types of skills needed by firms. They also permit various approaches to encouraging lifelong learning. Regulatory and/or institutional failure with particular interventions would also have to be taken into account.
