Training funds and the incidence of training : the case of Mauritius

100252 AUTHOR ACCEPTED MANUSCRIPT FINAL PUBLICATION INFORMATION Training Funds and the Incidence of Training : The Case of Mauritius The definitive version of the text was subsequently published in Education Economics, (Forthcoming 2015), 2015-02-24 Published by Taylor and Francis and found at http://dx.doi.org/10.1080/09645292.2015.1009418 THE FINAL PUBLISHED VERSION OF THIS ARTICLE IS AVAILABLE ON THE PUBLISHER’S PLATFORM This Author Accepted Manuscript is copyrighted by the World Bank and published by Taylor and Francis. It is posted here by agreement between them. Changes resulting from the publishing process—such as editing, corrections, structural formatting, and other quality control mechanisms—may not be reflected in this version of the text. You may download, copy, and distribute this Author Accepted Manuscript for noncommercial purposes. Your license is limited by the following restrictions: (1) You may use this Author Accepted Manuscript for noncommercial purposes only under a CC BY-NC-ND 3.0 IGO license http://creativecommons.org/licenses/by-nc-nd/3.0/igo. (2) The integrity of the work and identification of the author, copyright owner, and publisher must be preserved in any copy. (3) You must attribute this Author Accepted Manuscript in the following format: This is an Author Accepted Manuscript of an Article by Kuku, Oluyemisi; Orazem, Peter F.; Rojid, Sawkut; Vodopivec, Milan Training Funds and the Incidence of Training : The Case of Mauritius © World Bank, published in the Education Economics(Forthcoming 2015) 2015-02-24 CC BY-NC-ND 3.0 IGO http://creativecommons.org/licenses/ by-nc-nd/3.0/igo http://dx.doi.org/10.1080/09645292.2015.1009418 © 2015 The World Bank  Training Funds and the Incidence of Training: The Case of Mauritius Oluyemisi Kuku, IFPRI Peter F. Orazem, Iowa State University Sawkut Rojid, The World Bank Milan Vodopivec, University of Primorska and International School for Social and Business Studies, Celje January 2015 Abstract Training funds are used to incentivize training in developing countries, but the funds are based on payroll taxes that lower the return to training. In the absence of training funds, larger, high- wage and more capital intensive firms are the most likely to offer training unless they are liquidity constrained. If firms are not liquidity constrained, the fund could lower training investments. Using an administrative dataset on the Mauritius training fund, we find that the firms most likely to train pay more in taxes than they gain in subsidies. The smallest firms receive more benefits than they pay in taxes. JEL: M53; O15; O2; O55 KEYWORDS: training, general skills, firm-specific skills, training fund, externality, cross- subsidy, tax _____________________________ Corresponding author: Peter F. Orazem, Department of Economics, Iowa State University, Ames, IA, 50011-1070, USA. pfo@iastate.edu (515) 294 8656. Kuku: O.Kuku@cgiar.org Rojid: srojid@worldbank.org Vodopivec: milan.vodopivec@gmail.com . We appreciate numerous suggestions from the referees and financial support from the World Bank. 0  Training Funds and the Incidence of Training: The Case of Mauritius I. Introduction There are numerous market failures that would lead firms to underinvest in training. One is that training may increase a worker’s value not just in the firm that paid for the training but in other firms as well. Consequently, a firm that invests in training risks losing its investment to its rivals. The better strategy may be for the firm to free ride on its rivals’ investments by raiding their trained workers without having to invest themselves. The free-rider problem causes all firms hold back on their investments. A second reason for under-provision is if training is subject to returns to scale. Individual firm training investments will be more costly than if training were provided by a single provider. A third reason is that unlike physical capital, human capital cannot be used as collateral. Firms may face liquidity constraints in training investments if they are unable to borrow against future gains in labor productivity. Training funds are one approach to address the under-provision of training, practiced in both developing and developed economies. The sectoral training agreements common in Europe allow all the firms using a particular type of skill to agree to pay equally for training through the payroll tax and then share in the benefits of trained workers. The coordination forces all firms to internalize the training externality arising from labor mobility.1 In contrast, in developing countries a common training fund usually covers all sectors.2 Because these programs are not 1 The earliest training levy/grant programs in Belgium, Cyprus, Denmark, France and the Netherlands began as narrowly focused sectoral training programs in the 1960s and 1970s. See CEDEFOP(2008) for a summary of European training fund programs. 2 In a recent review, Johanson (2009) lists 62 countries with training funds worldwide. Most of these programs are found in Latin America (17 countries), Sub-Saharan Africa (17 countries), and Europe (14 countries). In contrast, there are only 7 programs in Asia and the Pacific Region. The most typical levy is about 1% of the wage bill, but with considerable variation from 0.25% of the wage bill in Uruguay; to 3% of the wage bill in Bahrain, Jamaica and Senegal; and to 4% of the wage bill in Burkina Faso. Types of training funded by training funds include external 1 focused on a common set of skills, they invariably involve cross–subsidization of training intensive firms by nontraining firms, and so the justification for the European training programs does not hold. Nevertheless, these programs could address other possible externalities and constraints: such funds could help to generate increasing returns to scale in the provision of generally valued skills, as well as, by providing a training subsidy, incentivize firms to increase investment in workers in the face of liquidity constraints. Even if these market failures exist, it is not clear that they are sufficiently large to outweigh the inefficiencies caused by a payroll tax that lowers the return to investment if the tax is borne by the firm. Additionally, costs associated with collecting taxes and administering the training funds are unnecessary if firms would have invested in training without the program. However, past studies have not examined whether these training fund programs are cost effective. Johanson’s (2009) comprehensive review of 62 national training funds concluded that despite vast amounts spent on training, evaluation has been largely anecdotal and limited to assessments of outcomes against targeted levels. This is particularly true in developing countries where studies have yet to establish that firms face lower marginal costs of training or increase their training investments as a result of the training funds. The need for evaluations of training funds is particularly urgent in Sub-Saharan Africa which faces the need to accommodate the fastest growing labor force in the world. There are numerous areas where public dollars could be used to enhance job growth, and so investments in training carry a high opportunity cost. When asked what factors hinder business growth, African firms rank insufficient job skills as 11th most important, behind such factors as transportation, training such as specialized courses in IT or language provided by training firms; and in-house training provided by enterprises themselves. Training duration typically varies from a few days to several months, but some will cover Master’s training that could last two years. 2 access to electricity, input costs, access to financing, and political instability (McKinsey and Company, 2012). It is not obvious that training is the best use of scarce resources. This paper uses the Mauritius Training Fund as a case study of the performance of training funds. We examine whether the firms that engage in training are those that would be predicted to train in a standard Becker (1993) model of training or if the training fund alters the incentives to train. Next, we examine the implied patterns of cross-subsidization from the firms paying into the system to the firms receiving the training subsidies. That analysis shows which industries are taxed in order to subsidize others and whether small firms subsidize large firms or vice versa. Finally, we examine whether there is any evidence that the training raises labor productivity. We find that the training subsidy does increases training for the smallest firms that would not otherwise train without the subsidy. However, large, capital-intensive, high-wage firms that would be expected to have the greatest incentive to train without the subsidy end up paying more in taxes than they receive in subsidies. Furthermore, the subsidies focus on classroom training that has the lowest returns rather than on in-house training that has the highest returns in evaluations. We conclude that in Mauritius, for medium and large firms, the adverse effect of the tax on training outweighs the incentive effect of the subsidies. As a result, the training fund may well lower rather than raise the incidence of training in the country. II. The Mauritius Training Fund Following the Human Resource Development Act of 2003, all registered firms in Mauritius are required to pay a training levy. The tax is proportional to the firm’s total base wage bill, the aggregate of wages paid workers excluding overtime, bonus and benefits. The 3 levy rate was 1% until 2008, and increased to 1.5% since then. However, only one-third of the tax is now used to reimburse training costs and two-thirds goes for unemployment benefits (Parliament of Mauritius, 2008). The government uses the training fund to reimburse firms for a portion of their training costs. All trainings need to be pre-approved by the Mauritius Qualifications Authority and firms apply for reimbursement after the training is delivered. According to the Training Fund rules, firms can be reimbursed up to ten times the tax they pay into the training fund. The reimbursement rate falls as the total expenditure on training increases, but the reimbursement can still be as high as five times the training levy paid for the most training intensive firms.3 The reimbursement rate does not depend on the type of training undertaken. The stated objectives of the training fund are to (i) promote human resource development in line with national economic and social objectives, (ii) stimulate a culture of training and lifelong learning at the individual, organizational and national levels for employability and increasing productivity; and (iii) provide the necessary human resource thrust for successful transformation of the economy into a Knowledge Economy. Only the last of these is sufficiently concrete to enable an evaluation, suggesting that the program should atypically induce training in the technology sector or other sectors that use information technologies. Table 1 presents summary information on the percentage of firms providing training by industry and firm size cells. In all 9 sectors, the proportion of firms investing in training increases with firm size. Propensity to train varies by sector between 6-10% for the smallest firms to 23-47% for the largest firms. Consistent with the stated objective to encourage the 3 For annual levy up to Rs 20,000, the maximum reimbursement is ten times levy paid; for a levy between Rs 20,000 and Rs 100,000, the maximum reimbursement is either Rs 200,000 plus five times the levy paid over Rs. 20,000 or Rs 300,000, whichever is the lower; for a levy above Rs 100,000, the maximum reimbursement is Rs 300,000 plus five times the levy paid over Rs.100,000. 4 growth of the knowledge economy, the probability of training is highest in Information Technology and Finance. Nevertheless, the training incidence in Mauritius is much lower than that reported for developed economies. For example, in the U.S., over 98% of firms with 50 or more employees provide training (Frazis, Herz, and Horrigan, 1995). We also report measures of training intensity for the firms that provided training. Because of smaller samples, we only report the industry-wide averages. Training intensity, both in hours and costs, varies significantly across sectors. Because workers can engage in multiple types of training per year, we report the averages per employee rather than per trainee session. Firms provided an average of 22 hours of training per employee per year, roughly half the hours training provided by firms in the U.S. (Frazis and Spletzer, 2005; Miller, 2012).4 The greatest time investment in training per worker is in transportation at almost 90 hours per employee per year. The least time invested in training is in construction. The average per employee training cost was almost 60 thousand rupees per employee or roughly $2,000 per worker. That amount is consistent with the direct plus indirect training costs per worker in the United States (Miller, 2012). The most costly training was in finance at over $3.000 per employee, even though the time invested was modest. Hotels also had relatively expensive training per hour. The relatively large per employee training cost in wholesale and retail trade and in community and social service reflects their relatively large time investment in training. Nevertheless, the reimbursement rate does not vary much across sectors and firm sizes despite the substantial differences in costs, measured in rupees or trainee time commitments. We computed the ratio of reimbursements received relative to training payments reported for all 27 4 To put the Frazis and Spletzer figures in per employee terms, we took the mean hours per trained worker in theior table 3 and incorporated the 0 hours of training for the 53% of workers that did not train. 5 firm size-sector cells. As we see in Table 2, there was a very slight pattern of rising average reimbursement rates by firm size, and only modest variation in average reimbursement rates across sectors. Across the 27 cells, the training fund covered an average of 50-65% of the reported training costs with the firms covering the rest. One might expect that the training fund should have induced most firms to invest at least modestly in training every year. Instead, only 9% of the firms participated in FY2008. The fact that training costs almost as much in Mauritius as in the United States may explain why firms are shy about offering training. Other training costs may also cause firms to shy away from training. Receipt of the training subsidy requires substantial paperwork, use of approved trainers, and prior approval of the training curriculum. The training is also subject to minimum participation of 10 workers if the training is offered in the workplace. These restrictions clearly limit the potential participation of smaller firms that may not have enough workers to train or sufficient expertise to manage the paperwork, consistent with the pattern of training by firm size found in Table 1. While small firms face disadvantages from participation, large firms also have been slow to respond to the Mauritius training fund. One problem is that the program focuses on reimbursement for formal training with greater restrictions on training offered in firms rather than classrooms. As shown in Figure 1, formal training plus overseas training initially accounted for nearly three-fourths of training reimbursements in the first year after the training fund was implemented. Since then, the formal training share has fallen steadily over time while in-house training increased in importance.5 Firms complained that the training provided by institutions was too generic to meet their needs. That assessment is consistent with the findings of Betcherman et al (2004) who found that on-the-job training and in-house training are particularly 5 Courses conducted for employees of one enterprise are considered as in-house training. 6 effective in evaluations conducted in developed, transition, and Latin American economies while classroom training has mixed or negative outcomes. If the training fund is eliminating a market failure due to liquidity constraints that constrain firm incentives to train, one would expect the program would have broad participation. Instead, Figure 2 shows that taxes levied on firms typically exceeded the training grants disbursed, so much so that contributions to the training fund were cut in half in FY2009, even as the tax on the wage bill was increased. The World Bank (2011) estimated that no more than 20% of Mauritian firms had provided formal training that could qualify for reimbursements over the first four years of the program. That percentage is below the 30% training incidence for Sub- Saharan Africa reported by Johanson (2009) and well below the training incidence reported for developed countries. The underutilization of training funds in Mauritius is not unusual. In Costa Rica, Gabon, Togo, and Zimbabwe, underutilized training funds were repurposed to other uses. In Colombia and Venezuela, training funds were used to create a large government training bureaucracy rather than encouraging firm in-house training. That pattern appears to be starting in Mauritius where the number of private training institutions is increasing even as their share of training provision is declining and firms are complaining about their services. Even if the Mauritius training fund is not fully utilized, it may still increase the propensity to train. To assess that, we need to establish a model of expected training in the absence of the government program. We turn to that next. III. Theory Becker’s (1993) theory of on-the-job training provides a useful framework for our evaluation, allowing us to predict which firms would invest in training under the Mauritius 7 training fund program. In Becker’s framework, general skills were observable and equally valued across all firms and so firms would only invest in skills that were specific to and hence only valuable in that firm. As demonstrated by Acemoglu and Pischke (1998, 1999), the firm might still pay for general training if information asymmetries or other labor market rigidities make workers immobile. Our framework is equally valid regardless of the firm-specific or general nature of the training.6 However, the theory does generate estimable conditions under which the training fund will succeed or fail. A firm’s incentive to invest in training depends on the anticipated returns to training compared to the opportunity costs and direct costs of the training. Let Ti be a dummy variable that indicates whether the ith firm invests in training. Training will occur if the expected net return from training Ri is positive. Probability that firm i trains is Pr (Ti = 1) = Pr (Ri > 0) ( 1) Ri will take the form 1