Human Capital
Human Capital represents
75% of world wealth it is also one of the most important drivers of economic growth investments in human capital are roughly 20‐25% of GDP including health, on‐the‐job training, etc.
Suppose the firm pays under firm specific human capital
The firm pays the worker J during training, which is higher than productivity To fully recoup its investment, the firm must pay the worker J after training, which is now lower than productivity BUT after the investment has been made, the worker has an incentive to ask for more!
Implications of firm specific human capital
Turnover is costly to both ... firm & employee have an incentive to stay together There is a potential Hold‐Up Problem risk that one or the other tries to renegotiate after the investment is made the greater this risk, the smaller the expected return & the smaller the investment sharing the investment reduces, but does not eliminate, this risk
Human Capital as investment
career from t = 0 ... T training during first period t = 0 productivity = Kt if trained/schooled; Ht otherwise r = real interest rate C0 = direct cost of training F0 = H0 - K0 >0 opportunity cost of training
If OJT under General Human Capital, the firm can and usually
charge the employee through below‐market wages during training. this kind of implicit arrangement is quite common for new employees, especially those with little experience
Who pays for OJT
consider general human capital
Thin markets for talent known as firm-specific human capital
human capital is the most extreme thin market: your firm values a completely different set of skills than the market, say λ = 1 & λ = 0 (or vice versa) skills that only have value at your current employer. a generalized version of the idea is relationship‐specific investments
Pure General Human Capital (GHC)
market value & value to the firm are the same any increase in skills implies you can earn more elsewhere you should be paid roughly the same at your firm or elsewhere unless you have a good match or non‐pecuniary benefits with your firm thus it is difficult for your employer to capture any return on the investment
NPV of Human Capital Investment
The IRR tends to be about 10% per year Who should invest more in skills? younger individuals, those who expect to stay in the workforce longer
Related Examples and One Solution to firm and general specific
An alternative solution? Non‐compete agreements
Implications of firm specific human capital
Hold‐Up Problems are less likely if there is sufficient trust or a strong reputation by one side or both implicit contract
Who pays for GHC the investment? Suppose the Firm pays The firm pays the worker J during training, which is higher than productivity The firm pays the worker J after training, which is lower than productivity After training the firm recoups the value of its investment only if the worker does not leave
If the worker leaves at t1, the firm loses area A If the worker leaves at t2, the firm loses area B Is there any incentive for the worker to leave? Yes! His knowledge is general, so he would be paid more at another firm. Solution: under GHC investment, the worker should pay for general training
Implications of GHC
Ignoring other factors such as non‐pecuniary benefits pay ≈ productivity turnover has no cost to either you or your employer the firm does not need to make investment decisions
Related Examples and One Solution
Intellectual Property raises similar issues: suppose a key employee is developing a new technology for your firm Like GHC, the employee might take (some of) its value if they quit because of imperfect patent protection Like FSHC, the employer likely contributed to cost of developing the technology o turnover can be costly to the employer
Alternative Solution: Employee Non-compete agreements
One way to reduce risk of employee Hold‐Up: add a non‐compete agreement to the contract often difficult to enforce in court legal system balances firm's interest in protecting assets, against employee's liberty in choosing employment
Related Examples and One Solution
Partnerships arise because of important shared investments You must pay key personnel much of the value that they create, or they will quit At best, you lose the benefits of the shared investment. At worst, if some of that investment is portable, they will compete against you A solution? Partnership ... also creates good incentives to invest and work hard an example of what we later call "selling the job" to the employee
Alternative Solution: Employee Non-compete agreements Alternative Solution: Employee Non-compete agreements
Possible clauses confidentiality/non‐disclosure require adequate notice before leaving (garden leave) require to describe new employer, job duties require to train successor; introduce to clients prohibit from recruiting colleagues to leave as well tie vesting to non‐compete performance after leaving
Alternative Solution: Employee Non-compete agreements Alternative Solution: Employee Non-compete agreements
Restricting outside options imposes a cost on employee compensate through higher salary or signing bonus when making offer if non‐compete signed after employment starts, compensate w/ lump sum also helps legal enforceability
Suppose the worker pays under firm specific human capital
The firm pays the worker according to his productivity during training, which is lower than J To fully recoup its investment, the worker should be paid his full productivity after training BUT after the investment has been made, the firm has an incentive to pay less than Kt (productivity after training)
Implications of on the job training (OJT)
The greater the odds of staying in your job, the more should you invest in your firm's desired skills, & vice versa The longer you work at a firm, the more will your skill investment match the firm's desired mix, & diverge from the market's desired mix
Implications of firm specific human capital
The same issue arises with any shared investment (e.g., joint ventures) one common solution, vertical integration/long term employment contracts ("slavery!"), is usually impossible in employment
who pays for GHC Investment?
The training you get at your current firm raises your productivity at this as well as other firms. Who pays for the investment?
Solution for firm specific human capital investments
the worker and the firm share the investment in specific training Wage profile is Wt
Thick markets for Talent
thick market: outside options similar to value to the employer, worker is more willing to invest in the firm's desired skill portfolio since it is similar to what the market values The extreme cases (thick) are usually called general human capital (GHC)
Implications of on the job training continued
thus the lower the chance you will leave the firm Different optimal training strategies for younger & older workers: 1. those who expect to quit or to stay 2. those with low or high tenure at your firm 3. different types of firms (jobs & skills)