2  Skills and Firm Productivity – An Organising Framework

This section provides an organising framework for sorting the evidence on how skills contribute to firm productivity. Three broad questions are explored: the broad types of skills required; the principal mechanisms by which skills contribute to technology adoption and increased firm productivity; and how skills are acquired over time.

2.1  Skills Contributing to Firm Productivity

Three broad categories of skills seem to be important in firms for production, organisational design and technology adoption, although in reality these skills types probably exist along a continuum.[3] Entrepreneurial ability is needed to identify and respond to market shocks and to pursue market opportunities. These abilities combine a mixture of risk taking, innovation, resource re-allocation, arbitrage, and coordination. Managerial capability provides the leadership and organisational skills required to oversee the effectiveness of production processes. Managerial capabilities affect the decisions about how to organise the set of production tasks, motivate workers, and, over time, to adapt the organisational structure. Employees’ technical skills enable the various production tasks to be undertaken. Higher skill levels improve the effectiveness of production processes, and allow advantage to be taken of technological improvements.

2.2  Mechanisms by which Skills Contribute

The skill level of a worker can influence firm productivity in three main ways. Rising skills can affect a worker’s own productivity in the given production tasks; there is the effect on firm productivity from the tasks that the worker performs with capital or technology; and the worker’s skill levels can directly affect the productivity of other workers in that firm, or the productivity of other firms.

2.3.1  Skill level

Higher skill levels can increase a worker’s own productivity, thereby improving the firm’s productivity. For example, more productive workers will complete a production task in a shorter period of time, and/or with higher quality. They should make fewer mistakes, be able to recognise and solve problems in the tasks they undertake, and may need less supervision. They are also more likely to be adaptable to changes in production processes and organisational structures. Skills can be combined within the enterprise in various ways. Thus, firms have to make choices around the combinations of people who contribute generalist and specialist skills, or high and low skill levels, in order to maximise firm productivity.

Given bounded rationality, a more skilled worker may be able to “process” or “communicate” more information in a given amount of time, and hence contribute to better decision-making. Both the breadth and depth of skills may matter. For example, a worker with greater “depth” in a particular skill may perform tasks requiring that skill more quickly, while a worker with greater “breadth” of skills may be more adaptable in undertaking a range of production tasks within a firm. Firms allow combinations of skills to be drawn together and organised to take advantage of synergies between skills, and to balance the gains from skill specialisation and the need for coordination. While there can be gains from greater specialisation in labour inputs, these will be offset by the costs of coordination. As coordination costs rise, generalist skills will be preferred.

2.3.2  Interactions with other firm inputs

Higher worker skill levels can improve firm productivity by making better use of other inputs such as capital investments or R&D activities or new technologies, and in the assimilation of knowledge embodied in capital investments. It seems likely that capital complements skilled labour, but is a substitute for unskilled labour. Nevertheless, a certain level of basic levels of skills may be required by workers for the operation of more sophisticated technology.

The optimal organisational structure is one that allows synergies in the use of mixes of inputs to be captured. Obtaining the full productivity gains from technological change may require changes in workplace organisation. Gains may also be available to firms from information management systems to assimilate external knowledge, manage internal knowledge, and apply that knowledge commercially. Both have implications for skill requirements.

2.3.3  Knowledge spillovers

The worker’s skill levels can directly affect the productivity of other workers in that firm through synergies in teams, or the productivity of other firms through knowledge spillovers like R&D activities. These occur because of the unique economic characteristics of skills and knowledge. Knowledge is non-rival because it can be used simultaneously by many, and its use is only partly excludable through institutions like patents or employment contracts. Knowledge spillovers are thought to be an important element in the growth process. Within the firm, knowledge transfers can occur between workers in teams. “Co-worker” effects can be significant: who you work with matters in terms of the use of jointly held knowledge. Further, workers changing employers can be a source of knowledge transfer between firms. In this case, skills that are developed in one firm then become available for use at another firm.

Spillovers can also occur between firms or within localised regions, either through market exchanges or by direct interactions with other firms. These transfers between skilled workers across firms lower the cost of knowledge accumulation. For example, the rate of diffusion of information technologies will be influenced at the firm level by the costs of adoption, which will be affected by the industry’s experience of implementing the technology. Shared knowledge or trust also reduces the costs of coordination. In addition, proximity of upstream or downstream firms can influence the level of specialisation within firms or locations, as in industry clusters or the proximity to suppliers or customers.

Spillovers can also arise from expectations about the behaviour of firms and workers in the choices of skill and technology mixes. Firms may make decisions about capital investments, and people may make decisions about skill investments on the basis of expectations about what they expect other parties will do. This possibility has given rise to concerns around coordination failures that affect the skill/technology mix adopted. The importance of path dependence increases where it takes much time and effort for a firm to change its resource and technology mix, or for workers to build up skills. An implication may be that the expected supply of more skilled workers can influence the adoption of a more technologically advanced trajectory.