Market failure or low-skills equilibrium?

As we know from countless growth accounting studies, the ability of a country to educate and train its citizens is a key determinant of economic development. There is also fairly strong evidence at the company level that a workforce with higher human capital generates higher productivity. In other words, not only are there strong incentives for governments to educate and train people, but there are also incentives at the firm level for companies to hire more educated workers and to offer training to their existing workers.

Many firms do train their workers, but it is clear from the evidence that the tendency to train declines with enterprise size. Large firms train more than medium-sized firms, and small firms train more than microenterprises. This suggests that there is a “sized-induced market failure” in enterprise training. We find size-related market failures in other aspects of the enterprise environment, with the most obvious case being access to finance. Large firms have much less difficulty than small firms in securing credit or other forms of finance (Vandenberg, Chantapacdepong and Yoshino 2016).

Barriers to training. Just as there are specific reasons why smaller firms have the less access to finance (i.e. information, collateral, loan size, and processing costs), there are evident reasons why smaller firms are less likely to offer training. Removing workers from production to attend training is more disruptive for small firms, and hiring in-company trainers, let alone establishing a training department, is costly and unaffordable for most small firms. Linking up with local training institutes and finding appropriate training courses can also be time-consuming and not always fruitful, and finding out where and how to apply for government training subsidies and taking the time to do so can further discourage employers.

Our analysis of data from over 5,000 enterprises across the People’s Republic of China, Indonesia, Malaysia, Thailand, and Viet Nam suggests a link between size and the propensity to train (Vandenberg and Trinh 2016). Only 7% of microenterprises offer formal training to their workers, compared to 39% of small firms, 70% of medium-sized firms, and 79% of large ones. When training is offered, the share of workers in the enterprise who are trained is much lower for small firms. In microenterprises that offer training, only 7% of the workforce participates, compared to 64% of the workforce in large firms. When we consider hiring practices, we see similar trends. Only 18% of microenterprises employ a workforce with at least 10–12 years of schooling. This share rises to 47% for both medium-sized and large enterprises.

Constraint or by intent? The fact that smaller firms train less does not, by itself, indicate that they find it difficult, costly, or time-consuming to do so. Instead, smaller firms may be less interested in providing training. They may feel that their workers have the skills required and that the enterprise has more pressing concerns for its sustainability or growth.

Fortunately, our enterprise data do provide some evidence on how enterprises view human capital. Enterprises were asked to indicate whether an “inadequately skilled workforce” was a major or very severe constraint on business performance. While 69% of large firms thought it was a constraint, only 27% of microenterprises thought so. Small and medium-sized firms were within that range. Thus, it seems that larger firms are more likely to see inadequate skills as a constraint; therefore, they are more likely to train their workers. We do note, however, that 27% of microenterprises saw inadequate skills as a constraint, and only 7% offered training. For small firms, the difference is smaller; 54% saw inadequate skills as a constraint, and 39% offered training.

To better determine whether smaller enterprises intentionally avoid training, we used econometric techniques. Our dependent variable was whether an enterprise provides training, and our explanatory variables included the enterprise size and whether it considered inadequate skills a constraint. We found that the latter variable was significant, but so too were the size variables. In other words, smaller firms trained less, even when we took into account their perception of whether inadequate skills are a constraint.

Low-skills equilibrium. Our results suggest that some smaller firms do not see skills as a business constraint; therefore, they do not offer training. They may operate in a low-skills equilibrium in which they can sustain adequate productivity and survive in a market segment that does not require well-trained and educated workers. Other small enterprises do see inadequate skills as a constraint, and either tackle this by organizing training or not providing training because the costs and difficulty are too great to overcome.

The policy implications follow directly from these results. For smaller firms that wish to train, governments can seek to reduce (i.e., subsidize) the costs and offer arrangements through local training providers that are easy to find, understand, and administer. For smaller enterprises that are less interested in training, the options are to leave these enterprises as they are or to try to impart the benefits of greater human capital in terms of enterprise performance.

Vandenberg, P. and L. Q. Trinh. 2016. Is There a Size-Induced Market Failure in Skills Training? ADBI Working Papers 598. Tokyo: Asian Development Bank Institute.
Vandenberg, P., P. Chantapacdepong, and N. Yoshino, eds. 2016. SMEs in Developing Asia: New Approaches to Overcoming Market Failures. Tokyo: Asian Development Bank Institute.
Paul Vandenberg is a visiting professor in the Faculty of Economics, Thammasat University, Bangkok, Thailand. He is currently on leave from the Asian Development Bank.

Photo: By NATO Training Mission-Afghanistan TSgt Samara Scott/4th Combat Camera, March ARB, CA/PAO Camp Stone, Herat, Afghanistan (110730-F-YY246-094) [Public domain], via Wikimedia Commons

Paul Vandenberg

About the Author

Paul Vandenberg is a Senior Economist in the Economic Research and Regional Cooperation Department of the Asian Development Bank.

One Response to Market failure or low-skills equilibrium?

  1. February 24, 2017 at 16:31 #

    The low skills equilibrium occurs because employers do not want to spend on their employees for training as would leave the firm in search of better opportunities and pay scale. It’s a problem of human resource that required to spend on certain search cost to hire one more skilled labor. However, it’s an opportunity cost for a small firm to retain its employees for medium to long-term. Therefore, low-skilled equilibrium strategy is advantageous and profitable for small firms as they need to pay less salary for low-skilled labor.

    In order to shift this market equilibrium, the government need bring regulations, standardize mandatory skills level of labor across the industry and standardize industry requirements for a level of skill set that employee need.

    The second strategy is to bring minimum wage policy across sectors so they have to hire a labor certain qualified skills and qualification.

    A human resource strategy at national and sub-national level is required for MSMEs.