Ifo / CESifo & OECD Conference on Regulation:

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1 A jont ntatve of Ludwg-Maxmlans Unversty s Center for Economc Studes and the Ifo Insttute for Economc Research Ifo / CESfo & OECD Conference on Regulaton: Poltcal Economy, Measurement and Effects on Performance 9 30 January 010 CESfo Conference Centre, Munch Barrers to Entry, Deregulaton and Workplace Tranng: A Theoretcal Model wth Evdence from Europe Andrea Bassann and Gorgo Brunello CESfo GmbH Phone: +49 (0) Poschngerstr. 5 Fax: +49 (0) Munch E-mal: offce@cesfo.de Germany Web:

2 Barrers to Entry, Deregulaton and Workplace Tranng * : A Theoretcal Model wth Evdence from Europe by Andrea Bassann (OECD, ERMES-Pars, and IZA) Gorgo Brunello (Padova, CESfo and IZA) Ths verson: 1 June 009 Abstract We study the mpact of barrers to entry on workplace tranng. To motvate the emprcal analyss, we develop a model of tranng n mperfectly compettve product and labour markets. The model ndcates that there are two contrastng effects of deregulaton on tranng. As stressed n the lterature, wth a gven number of frms, deregulaton reduces the sze of rents per unt of output that frms can reap by tranng ther employees. Yet, the number of frms ncreases followng deregulaton, thereby rasng output and proft gans from tranng and mprovng nvestment ncentves. The latter effect always prevals. Our emprcal analyss, based on repeated cross-secton data from 15 European countres and 1 ndustres, confrms the predctons of the model and shows that deregulaton ncreases tranng ncdence. Key words: tranng, product market competton, Europe JEL codes: J4, L11, O43 * The vews expressed here cannot be attrbuted to the OECD or ts member countres. We are grateful to Alex Hjzen and Laura Nn Varta for ther help wth the data and to Kenn Arga, Georges Bresson, Mara De Paola, Fath Fakhfakh, Marco Leonard, Franck Malherbet, Alfonso Rosola, Armn Schmutzler, Francsco Serranto, Sad Souam, Katsuya Tak, Govanna Vallant, and to the audences n Cergy, Gerona, Madrd, Mlan, Munch, Osaka, Pars and Zurch for comments and suggestons. The usual dsclamer apples. Address for correspondence : OECD, rue André Pascal, Pars Cedex 16, France; Ph.: e-mal: andrea.bassann@oecd.org. Address for correspondence : Department of Economcs, Unversty of Padova, va del Santo 33, Padova, Italy; Ph.: ; e-mal: gorgo.brunello@unpd.t. 1

3 Introducton Product and labour market deregulaton have attracted consderable attenton by economsts and polcy makers, and there s a broad concern that these regulatons can hamper growth and ncrease unemployment (see e.g. Aghon and Howtt, 1998, Blanchard and Gavazz, 003, Alesna et al, 005). Emprcal research on the economc effects of product market regulaton and deregulaton has focused so far on employment (Kugler and Pca, 004), productvty growth (Ncolett and Scarpetta, 003, Aghon et al. 009), nvestment n captal stock (Alesna et al, 005), nnovaton (Aghon et al., 005), and easness to start a busness (Djankov et al, 001). Ths paper develops a theoretcal and emprcal analyss of the relatonshp between product market regulaton / deregulaton and workplace tranng, whch we defne as the accumulaton of human captal takng place whle n employment and after school completon. We beleve that lookng at tranng s mportant because the producton of sklls s consdered as one of the man factors affectng productvty growth (see e.g. OECD, 007). A casual look at avalable ndustry-level crosscountry data reveals that the degree of strngency of product market regulaton and the tranng partcpaton rate are negatvely correlated. Usng data from the European Labour Force Survey and the OECD regulatory database whch cover the years , Fgure 1 llustrates ths for 15 European countres and 3 non-manufacturng sectors (energy, transports and communcaton), for whch data are avalable. Yet the prevalng vew n the labour economcs lterature s that product market competton depresses tranng because t compresses the sze of the rents that can be approprated by frms whch nvest n human captal and pay for most of job-related tranng (see e.g. Acemoglu and Pschke, 1999, Gersbach and Schmutzler, 001, 006) 1. Ths vew appears to overlook a standard fndng n the theory of ndustral organzaton: a frm s ncentves to reduce unt costs - for nstance by tranng more workers - do not depend on the sze of rents per se but on the senstvty of rents to unt cost reductons (see e.g. Boone, 000, and Aghon et al., 1997). In the case of prce competton (that s when frms set prces rather than quanttes), f frms have smlar producton costs, t s well known that greater competton ncreases ncentves to reduce unt costs even f rents defned n terms of profts per unt of output fall (see 1 The only excepton s Autor (001) who studes frm-sponsored tranng n the Temporary Help Sevce (THS) ndustry. In hs model tranng s provded at the tme of hrng and s essentally used by THS frms as a screenng and selecton devce. Greater product market competton ncreases the pressure to secure hgh-ablty workers and the need to use tranng as a way to attract and select them. Hs model therefore appears to be specfc to the THS ndustry.

4 e.g. Aghon et al., 001). Ths occurs because reducng costs allows reducng prces and the senstvty of product demand to relatve prces s greater, the greater the degree of competton. Fgure 1. The correlaton between tranng and regulaton tranng regulaton Note: The tranng partcpaton rate refers to tranng taken n the 4 weeks precedng the survey of full-tme employees aged between 5 and 54 years and wth at least 4 weeks of tenure. The regulaton ndcator covers all aspects of ant-compettve regulaton (excludng publc ownershp) and ranges between 0 no regulaton to 6 maxmum regulaton. The sector average of each varable has been subtracted to make comparable n a sngle charts fgures from dfferent ndustres. Data refer to averages for for 3 -dgt (letter) sectors (Energy, Transport and Communcatons) and 15 countres (Norway and pre-enlargement EU excludng Luxembourg). Sources: OECD regulatory database and Eurostat's European Labour Force Surveys. In ths paper we argue that a smlar mechansm apples to the nvestment n human captal by frms, nsofar as frms pay for tranng as a mean to reduce unt costs (see e.g. Stevens, 1996, Acemoglu and Pschke, 1999). We develop a model whch casts the tranng decson n an economy characterzed by mperfectly compettve product and labour markets where frms are ex-ante dentcal and compete n the product market by settng prces, as n Blanchard and Gavazz (003). We show 3

5 that n equlbrum deregulaton has two contrastng effects on tranng. On the one hand, a reducton n the barrers to entry for a gven number of frms compresses profts per unt of output, and therefore tends to depress tranng (we wll call ths rent effect hereafter). Ths s the mechansm usually stressed n the lterature. On the other hand, there s an elastcty or busness stealng effect: condtonal on profts per unt of output, addtonal frm entry due to deregulaton ncreases the output (and therefore proft) gans from tranng and rases the employer s ncentve to nvest n human captal. Output gans ncrease because addtonal tranng reduces the relatve product prce and the response of output to prces s greater, the greater the degree of competton n the product market. We show that the latter effect prevals on the former and conclude that deregulaton ncreases tranng. We frst derve the equlbrum and descrbe the comparatve statcs when: a) tranng s frm specfc and pad by frms; and b) wages are the outcome of the bargan between employers and workers. We focus on tranng pad and organzed by frms because ths s the bulk of workplace tranng (see Bassann et al., 007, and the references theren), and on barganng n lne wth the mportance of collectve wage determnaton n Europe, to whch our emprcal analyss apples. Our emphass on frm specfc tranng s also motvated by the European perspectve. In hs comparatve analyss of labour markets, Wasmer (006) argues that n Europe hgh employment protecton facltates the nvestment n frm - specfc sklls and reduces labour moblty. In the US, nstead, lmted protecton favours both the accumulaton of more general sklls and hgher moblty of workers. Our key results, however, apply also when tranng s general and the margnal cost of tranng s lower than the margnal cost of hrng for any value of tranng, because labour market frctons substantally reduce the transferablty of general sklls, makng them de facto specfc, as dscussed by Acemoglu and Pschke (1999). Moreover, we show that the postve relatonshp between deregulaton and tranng holds also when tranng s fully general, hrng costs are low, the employee nvests and bears the tranng costs and there s no wage barganng. The reason s that, wth addtonal frm entry due to deregulaton, the output gans from employng traned workers ncrease, the demand for tranng mproves, and so does ts supply. The fndngs of the theoretcal model are a useful gude to our emprcal research. Emprcal work on product market competton and tranng s scarce. We are aware of only two studes on the ssue and both pont to a postve relatonshp between competton and tranng. Autor (001), shows that the Herfndhal ndex and tranng are negatvely correlated n US temporary help frms, whch A smlar effect s stressed also by Vves (006), who nvestgates the relatonshp between competton and nnovaton, and Rath (001), who looks at how competton affects manageral ncentves. 4

6 suggests that less competton reduces tranng. In a mult-country study of Europe, Bassann et al (007), fnd evdence of a negatve and statstcally sgnfcant correlaton between the ndex of product market regulaton developed by the OECD and tranng ntensty, thereby supportng and generalzng Autor's fndngs. One potental drawback of mult-country aggregate studes s that, by explotng only the country and tme dmensons, they do not allow to control for many confoundng factors that mght affect tranng and vary across country and over tme. One way to overcome ths lmt s to add at least one addtonal dmenson to the data, the sector, as we do n the current paper. Wth data whch vary by country, year and sector, we can compare a treatment group, whch conssts of the sectors drectly affected by our measure of deregulaton, wth a control group, composed of those sectors whch are not affected drectly by such measure, whle at the same tme controllng for country and country by tme specfc effects. The assgnment to sectors s random nsofar as we can safely rule out the possblty that frms antcpatng polcy reform can swtch sector of producton. Gven the costs of swtchng sector, we beleve that ths source of endogenety s of second order of relevance. We use the OECD database on product market regulaton whch has been desgned to pck up regulatory reforms n tradtonally heavly regulated sectors, such as transport, communcaton and publc utltes. We consder these sectors as our treatment group, and contrast ther behavour wth respect to tranng wth the control group, whch conssts of the manufacturng sector, lmtng our analyss to European countres. After the mplementaton of the European Sngle Market Programme (SMP hereafter) n the early 1990s, we can assume that no country/sector-specfc regulatory reform affected the manufacturng sector, whch therefore qualfes as a genune control. 3 By comparng tranng ncdence n these sectors, we try to dsentangle the effects of deregulaton on tranng from other confoundng factors, whch affect both groups. To ths purpose we match regulaton data wth tranng data from the European Labour Force Survey (ELFS) as well as several other sector-level databases and obtan a rch sector-level database of tranng covarates. Our econometrc analyss shows that reducng product market regulaton ncreases tranng ncdence, n lne wth the predctons of the theoretcal model 4. The estmated effects are not small: dependng on the selected measure of regulaton and on the emprcal specfcaton, a 10 percent 3 The manufacturng sector, however, could be affected ndrectly, because of the close lnkage among sectors typcal of modern economes. 4 Needless to say, our emprcal results can be consstent wth alternatve theoretcal constructs. In ths paper, we do not attempt to dscrmnate our theory aganst alternatve hypotheses. More modestly, we develop a theoretcal model whch s consstent wth the emprcal fndngs. 5

7 reducton of regulaton ncreases tranng ncdence n the exposed ndustres by.8 to 5 percent. One mght queston whether the OECD ndcators can adequately capture the regulaton and deregulaton processes takng place n the treated ndustres. If yes, we would expect these ndcators to postvely affect ndustry specfc proftablty. We show that ths s the case when proftablty s measured by the observed Lerner ndex (defned as the average share of the value of output that exceeds varable costs, see e.g. Klette, 1999). We also decompose the margnal effect of deregulaton on tranng ncdence nto ts negatve effect on the Lerner ndex and the margnal effect of a lower Lerner ndex on tranng, and show that the former s negatve and the latter s postve lower profts are assocated to lower rents but also to a hgher number of frms, and the overall effect on deregulaton on tranng s postve. The paper s organzed as follows. In the frst secton we develop the theoretcal model. The subsequent sectons ntroduce the emprcal strategy and the data and present our estmates of the relatonshp between tranng and product market regulaton. Conclusons follow. 1. The Model 1.1 Frm-specfc tranng and wage barganng Followng Blanchard and Gavazz (003) and Stevens (1996), consder a three stage model economy where each frm produces a dfferentated product usng labour. The number of frms m s determned by an entry condton, whch s affected by product market regulaton. The logcal sequence of the model s as follows: frst, frms decde entry (let us call ths stage zero); second, each frm hres a number of (unsklled) workers and provdes them wth a gven amount of tranng, payng the related tranng costs (call ths frst stage); thrd, and condtonal on tranng, frms and workers bargan over wages and employment or over wages only f the employer (credbly) commts to employ all tranees n fnal producton (call t second or fnal stage). 5 Condtonal on the amount of tranng, prces are set when employment s determned. Producton occurs at the end of the sequence. As standard n the tranng lterature (see e.g. Acemoglu and Pschke, 1999, Stevens (1996) or Bassann et al., 007), we assume that no tranng can occur after the barganng. In both the decson to enter and n the choce of how many workers to tran, each employer has full nformaton and can 5 Our results can be easly generalsed to the case where workers have no barganng power and are pad ther reservaton wage. 6

8 perfectly foresee the wages she wll pay, the level of employment and the prces at whch she wll be able to sell her goods. Frms n ths economy share the same producton and tranng technology, and the same elastcty of product demand. Rsk neutral homogeneous workers have the same reservaton wage, and there are no exogenous separatons of workers from frms. Furthermore, mparted sklls are frm specfc (an assumpton that we relax n sub-secton 1.). 6 Each frm operates the technology Y = AL, where Y s output of frm, A s a productvty parameter and e e L s employment n effcency unts, whch depends on the amount of tranng gven to each employee τ 0. Hereafter, we shall call ths amount tranng ntensty. We assume that the (real) cost of tranng per employee be a convex functon of tranng ntensty τ µτ c( τ ) = [1] where µ s a scale parameter. Ths assumpton captures decreasng returns n the producton of human captal and rules out corner solutons for optmal tranng. 7 Tranng affects productvty and labour n effcency unts s gven by e L ( 1+ τ )L = where L s employment. Hence, the producton functon can be wrtten as Y = A 1+ τ ) L. 8 Snce the number of employees cannot be greater than the number of ( workers recruted and traned n the frst stage T, t must be that L T. Followng Blanchard and Gavazz (003), we assume that each frm faces the followng product demand functon θ Y P Y = [] m P where θ = σg( m) > 1 s the absolute value of the elastcty of demand wth respect to the relatve prce, 6 The assumpton s less restrctve than one mght thnk nsofar as each frm mght have an dosyncratc combnaton of general sklls (see e.g. Lazear, 003). 7 Decreasng returns can arse for nstance because the margnal productvty of traners s decreasng n tranng ntensty. 8 We mplctly assume that the employees of frm have the same level of sklls, and that the employer cannot gan by recrutng both traned and untraned workers. We also assume that each unt of tranng ncreases the effcency of labour by one unt. Ths s just a normalsaton that smplfes the analyss wth no qualtatve mpact on results. 7

9 g whch ncreases n the number of frms ( > 0 ) 9, σ s a sutable constant, Y s aggregate output, and m P and P are the prce set by frm and the average prce respectvely. Defne net and gross profts as net and gross of tranng costs. The characterzaton of the equlbrum proceeds by backward nducton and starts wth the bargan n the second and fnal stage. Ex-post wage barganng s justfed by the fact that, when frms nvest n frm specfc tranng, workers cannot commt to ex-ante wages but re-contract after the tranng nvestment has taken place (Malcolmson, 1997). It s also a plausble characterzaton of European labour markets, where wages are often set by collectve barganng between employers and trade unons (see Nckell, Nunzata and Ochel, 005). In the event of settlement, employed workers earn W V, where V s the reservaton wage. Falure to settle dsrupts the producton process to the pont that no producton occurs and the partes agree to separate. In ths event the frm makes zero profts and workers earn ther reservaton wage V. We characterze the barganng as a cooperatve Nash game, and defne the Nash maxmand as Ω [( W V ) L ] + (1 δ ) ln[ PY L W ] = δ ln [3] where δ 1 s the relatve barganng power of labour and the second element on the rght hand sde of [3] s the gross nomnal proft from a postve settlement accrung to the employer 10. Consder two alternatve settngs: n one settng, each frm ether can credbly commt to employ n the second stage all the workers who were traned n the frst stage or s forced to do that by strct dsmssal regulatons. In these crcumstances, second stage employment s fxed and the partes bargan only over wages. In the other settng, there s no strct regulaton and the employer does not commt to employ all tranees. As a consequence, n the second stage both wages and employment are barganed over, subject to the constrant that the number of employees cannot exceed the number of tranees set n the frst stage 11. We start wth descrbng the equlbrum under the former settng (call t 9 Ths follows from the fact that an ncrease n the number of products assocated to frm entry rases the elastcty of substtuton between products. As standard n ths type of models, we also assume that the number of frms s suffcently large that the frm cannot affect aggregate varables wth ts own decsons. Ths s one of the key dfferences between our model and Gersbach and Schmutzler (001, 006) who consder strategc nteractons n a duopoly (wth no entry). 10 Profts are gross because tranng costs n the second stage are bygones. 11 We assume that n ths case the partes are nvolved n effcent barganng. An alternatve characterzaton would be the rght to manage model, where the employer retans authorty over employment determnaton. We follow Blanchard and Gavazz n the preference for effcent barganng, whch they argue has the advantage of capturng the possblty that frms are not operatng on ther demand for labour. 8

10 the commtment equlbrum ). We do so for expostonal reasons, snce the dervaton of the equlbrum s smple and more ntutve n ths settng. We then show that the same equlbrum also holds and s unque n the absence of commtment. We conclude ths sub-secton by statng the key testable mplcaton on the relatonshp between product market deregulaton and frm-specfc tranng. In the next sub-secton we show that the same key mplcaton holds also n the case of general tranng The commtment case Wth employment equal to the number of tranees, the partes n the second stage bargan over wages to maxmse equaton [3]. The outcome of the bargan n frm s W Y = δ P + ( 1 δ ) V = V + δ ( P A(1 + τ) V ) [4] L Each employee s pad the outsde opton plus a share of total rents per worker, a standard result. Employer n the frst stage nternalses the wage rule [4] and chooses tranng ntensty and the number of tranees (and therefore employment and prces) to maxmze her net real profts 1 Π P = (1 δ ) P V µτ Y P (1 δ ) PA(1 + τ ) A(1 + τ ) m P θ [5] The terms wthn and outsde the braces on the rght-hand sde are net real profts per unt of output π and output Y respectvely. Snce L = T under commtment, equaton [5] can also be wrtten as: Π m = (1 δ ) Y 1 θ 1 V P µτ 1 ( A(1 + τ ) T ) θ (1 δ ) T T For θ < +, proft maxmsaton wth respect to the number of tranees yelds 1 That s, nomnal profts dvded by the average prce. 9

11 P P = θ V + µτ ( θ 1) PA(1 + τ) (1 δ ) A(1 + τ) [6] The relatve product prce of frm s a mark-up on the sum of unt labour costs V PA( 1+τ) - net of the share of rents accrung to workers - and unt tranng costs ncreased by the factor (1/(1-δ)). 13 The maxmsaton of profts wth respect to tranng ntensty τ yelds µτ, wth the latter component A(1 + τ ) 1 1 (1 δ ) θ P A P = µτ [7] Substtutng [6] nto [7] and smplfyng gves the followng second order equaton n tranng ntensty µτ + µτ V P ( 1 δ ) = 0 whch can be solved to yeld V µ ± µ + µ (1 δ ) τ = P > 0 [8] µ Snce both V and the parameters µ and δ do not vary across frms, t must be that τ = τ, mplyng that all frms select the same tranng ntensty for ther employees. It follows from ths and equaton [6] that, at the optmal level of tranng, relatve prces are the same across frms. Snce n general equlbrum we cannot have that all frms have a relatve prce above or below 1 (see Blanchard and P Gavazz, 003), t must be that P s equal to 1. Usng ths result nto [7] we obtan the key expresson 13 Ths s due to the fact that tranng benefts are shared but tranng costs are borne only by the frm. If workers have no barganng power, relatve prces n equaton [6] are a mark-up on labour and tranng unt costs. 10

12 ( θ 1) τ = A (1 δ ) µ θ [9] whch shows that tranng ntensty n equlbrum s an ncreasng functon of the elastcty of demand θ and, therefore, the number of frms m. To better explan ths result, we use equaton [6] and the fact that relatve prces n equlbrum are equal to 1 n the defnton of profts per unt of output π to obtan δ π = 1 [10] θ whch plugged nto [9] yelds A τ = π ( θ 1) µ [11] Tranng ntensty s ncreasng n net real profts per unt of output π and, condtonal on π, s decreasng n the tranng cost parameter µ and ncreasng n the productvty parameter A as well as n the elastcty θ. The relatonshp between tranng ntensty and θ reflects both a rent and a busness stealng effect. The former effect has negatve sgn and occurs because an ncrease n θ reduces profts per unt of output π and the benefts of tranng. The latter effect has postve sgn and comes from the fact that the output (and proft) gans from tranng are ncreasng n θ: tranng ncreases productvty, relatve prces are decreasng n productvty and the response of output to relatve prces s greater, the hgher s θ. It turns out that the latter effect always domnates the former. Therefore, more product market competton that ncreases the number of frms and elastcty θ unambguously ncreases tranng ntensty n equlbrum, as shown by equaton [9]. In the long-run, the equlbrum number of frms s determned by the condton that net profts per unt of output π must be equal to the cost of entry per unt of output ρ: δ π = 1 = ρ [1] θ 11

13 The assumpton that ρ s proportonal to output s convenent and used also by Blanchard and Gavazz (003). We show n the Appendx that our results stll hold when we specfy the entry cost more conventonally as a fxed cost. Equaton [1] mples that a fall n the costs of entry ncreases the number of frms and θ. As a consequence, profts per unt of output are reduced untl the arbtrage condton [1] s satsfed. We assume that ρ can be taken as exogenous or determned by publc polcy. A reducton n ρ can be brought about by lberalsaton reforms lowerng regulatory barrers n the product market. For nstance, we can assume that ρ = f (R), where R measures the strngency of regulatory barrers and f / R > 0. Pluggng [1] nto [11] we obtan τ = A ( θ 1) ρ µ [13] whch, takng nto account the relatonshp between θ and ρ descrbed by equaton [1], yelds: τ = A ( 1 δ ρ) µ [14] where ρ < 1 δ because θ > 1. We summarse our results n the followng proposton: Proposton 1. In the commtment case, the long run equlbrum n the presence of postve entry costs ρ exsts and s unque. A reducton n entry barrers whch corresponds to a reducton n the parameter ρ ncreases tranng ntensty. In comparatve statcs terms, the effect of product market deregulaton on tranng ntensty s llustrated n Fgure, where contnuous lnes n the ( θ, τ ) plane refer to the ntal equlbrum and dashed lnes to the new equlbrum. Tranng ntensty along the schedule TT assocated to equaton [13] tends to zero when θ 1 and ncreases wth θ and the number of frms 14. The schedule MM assocated to equaton [1] s a vertcal lne, whch smply descrbes the relatonshp between entry θ = m g > m 14 Recall that σ 0. 1

14 δ costs and the number of frms. Ths lne cuts the horzontal axs at θ = 1 >1. Therefore, the two ρ schedules certanly ntersect (exstence of equlbrum) and do so only once n the relevant doman (unqueness). τ MM TT θ Fgure : The effect of reducng barrers to entry n the commtment case A product market deregulaton whch reduces entry barrers and the value of ρ shfts the MM curve outwards and the TT curve downwards. The overall effect s to ncrease the number of frms unambguously. There are two effects on tranng ntensty: frst, and for a gven number of frms, lower entry barrers rotate the TT schedule downwards, 15 because they mply lower net profts per unt of output, thereby dampenng tranng ntensty. Ths s the rent effect usually stressed n the lterature. Second, the number of frms n equlbrum s hgher and the MM shfts outwards. Tranng ncreases along the new TT schedule, because the output gans from tranng are greater (the busness stealng effect). Snce the latter effect s larger than the former, equlbrum tranng ntensty 15 The barycentre of the rotaton s the pont (1,0). 13

15 ncreases The no-commtment case In ths sub-secton we argue that the commtment equlbrum descrbed above s an equlbrum even n the absence of commtment. Our argument here s only verbal, but the formal proofs are avalable n the Appendx. We proceed n two steps, whch correspond to the two lemmas presented n the Appendx. Frst we show that, startng from the commtment equlbrum, barganng outcomes nvolvng any employer and her workers cannot produce a level of employment L that dffers from the equlbrum number of tranees T. On the one hand, L < T s not a proftable devaton from the equlbrum: f the barganng par were free to devate, t would bargan for L > T. The ntutve reason s that, n the second stage, the employer and her workers bargan over employment wthout nternalsng tranng costs, whch are bygones and do not affect the Nash maxmand (cf. equaton [3]). By contrast, as shown n the prevous subsecton, T s set n the frst stage by takng nto account those costs that are ncreasng n T. On the other hand, L > T s not feasble because tranng s only possble n the frst stage, and there s no avalable sklled worker who can be hred n the labour market. Therefore, tranng n the frst stage acts as an effectve commtment devce. Second, let us defne an accommodatng strategy as a strategy that selects n the frst stage a tranng ntensty τ and a number of tranees T whch accommodates the level of employment that each frm expects to be chosen by the barganng partes n the second stage f they could bargan over wages and employment wthout any constrant. We show that ths strategy s always less proftable than a non accommodatng strategy, whch sets a relatvely low number of tranees n the frst stage and by so dong bnds employment n the second stage to the constrant L = T. The ntuton here s that, n the absence of commtment, the level of employment set by barganng partes n the second stage tends to be too hgh because, as dscussed above, the employer and her workers bargan over employment n the second stage wthout nternalsng tranng costs. By accommodatng ths employment level n the frst stage, the employer s forced to bear the assocated tranng costs. A natural way to reduce these costs s to te her own hands and tran a smaller number of workers n the frst stage, thereby constranng employment n the second stage. Snce the barganng partes cannot proftably devate n the second stage from the commtment equlbrum, and no sngle frm can proftably pursue an accommodatng strategy that allows 14

16 employment to be freely chosen n the second stage, employment s effectvely constraned to be equal to the ex-ante number of tranees even n the absence of commtment, and the followng proposton holds: Proposton. In the presence of postve entry costs ρ, and gven the workers barganng power δ, the cost parameter µ and the productvty parameter A, a combnaton of tranng ntensty τ, number of tranees T, wages W and employment L that s an equlbrum n the commtment case s also the unque equlbrum n the no-commtment case. Proof: see the Appendx. In the extreme case when ρ = 0 and the number of frms goes to nfnty, there are no rents, whch mples no scope for busness stealng effects because frms cannot trade off lower profts per unt of output for greater output. Therefore, equlbrum tranng s zero. The case of no entry costs looks, however, mplausble and, at best, apples to a relatvely small number of specfc markets. 16 Hence, we can establsh the followng corollary, whch yelds a testable mplcaton and provdes an explanaton for the emprcal pattern shown n Fgure 1: Corollary 1. A reducton n entry barrers correspondng to a reducton n the parameter ρ that does not lead to perfect competton n the product markets ncreases frm-specfc tranng ncdence ndependently of whether employers can or cannot commt to a gven employment level. 1. General tranng In the economy descrbed so far, each frm nvests n frm specfc tranng and s wllng to pay the necessary tranng costs. Moreover, workers and employers bargan over wages and employment. As already stressed, we beleve that the emphass on barganng and specfc tranng s justfed by the fact that our data come from European countres. However, we would lke to know 16 For example, when we use the tme-varyng data on whch Fgure 1 s based, n only 3% of the avalable observatons the ndcator of ndustry-specfc regulatory barrers to competton s equal to zero. Ths would mply that, n our data, competton was not perfect n at least 97% of the observatons (and probably n fewer of them, snce absence of antcompettve regulaton s only a necessary condton for perfect competton). 15

17 whether our results are more general and apply also to other economes where collectve barganng plays a mnor role and/or tranng tends to be more general. In ths sub-secton, we consder an alternatve specfcaton of the model where frm-specfc tranng s replaced by general tranng, and the wage of traned workers s also determned by the nteracton of demand and supply. Assume that sklls are general and that frms have the opton of hrng sklled labour from the labour market or from other frms (poachng). Wth frm-specfc sklls, no traned worker s avalable n the market. If tranng s general, however, workers can be traned by one frm and swtch employer n the second-stage f there are employers wllng to offer them a hgher wage. If hrng were costless and hred workers were as productve as workers traned n-house, no frm would be wllng to tran and bear the tranng costs. 17 However, hrng sklled labour n an mperfectly compettve labour market s costly, ether because sklls are not fully transferable or because of the presence of frctons and nformaton asymmetres. For example, the recrutment of sklled labour requres a costly screenng actvty both n terms of tme and resources to dstngush between sklled and unsklled applcants and to measure the sklls of potental hres. Snce the cost of screenng s lkely to rse wth the level of sklls, we make the convenent assumpton that hrng costs h per employee are gven by where η s a non-negatve scale parameter. ητ h( τ ) =, When the margnal cost of tranng s lower than the margnal cost of hrng, the analyss n Secton 1.1 apples. In ths case, the employer s wllngness to pay for tranng s justfed because labour market frctons ncludng search and nformatonal asymmetres substantally reduce the transferablty of general sklls from a frm to another, as dscussed by Acemoglu and Pschke (1999). Consder next the case when hrng s less costly than tranng. Wth no heterogenety n the technology and n the costs of hrng and tranng, all frms prefer to hre sklled labour than tran unsklled labour. But wth no tranng by frms there can be no hrng of sklled labour, unless workers 17 As shown by Gersbach and Schmutzler (001), ths statement may not hold f the number of frms n the market s small (and fxed), so that aggregate varables cannot be taken as gven by the frm as t happens n our model - because they are affected by ts own behavour. In ther model, the margnal productvty of tranng s a decreasng functon of tranng, the number of frms s small and entry s not possble. Therefore, even wth no hrng costs, each frm s able to keep at least a fracton of ts own traned workers, even f all other frms do not tran and prefer to poach. Ths occurs because the frm s margnal beneft from employng sklled workers s decreasng n the employment level, whch mples that each frm wll employ an equal number of sklled workers. The share of workers traned n-house that the frm wll be able to keep wll be therefore at least 1/m, where m s small and fxed. As competton dampens the senstvty of the frm s margnal beneft from employng sklled workers to employment, ths type of model mples that competton reduces tranng nvestment by frms. By contrast, n a standard model of monopolstc competton, such as ours, n whch the number of frms s assumed to be large, essentally all workers can be poached, and ths effect s always neutralsed. 16

18 themselves are wllng to bear the tranng costs. For each worker, let the cost of tranng be assume that wages are a functon of tranng ntensty, W = W (τ ) 18. Then homogeneous workers wll nvest untl the margnal beneft of the nvestment s equal to the margnal cost ξτ and ' W ( τ ) = ξτ [15] where the prme s for the frst dervatve. The demand for tranng ntensty by frms s obtaned by maxmsng profts per employee 19 Π L = Y L m θ θ { AL( 1+ τ )} τ 1 W ( τ ) P η The frst order condton wth respect to τ s 1 ' 1 A = W ( τ ) + ητ [16] θ where we have mposed the equlbrum condton = 1. Usng [15] n [16] we obtan that tranng s P gven by P 1 A τ = 1 [17] θ ( ρ) ξ + η where θ s a negatve functon of entry costs per unt of output ρ. The above equaton ndcates that, when workers nvest n general sklls, a deregulaton of the product market whch rases the number of frms and the elastcty of product demand θ generates hgher tranng ntensty because t ncreases the Y 18 In the symmetrc equlbrum, employment n each frm s gven by L =. Notce that the margnal cost of ma ( 1+ τ ) tranng for the worker should not be confused wth equaton [1], whch refers to the employer. 19 Snce frms are homogeneous, we drop the subscrpt. 17

19 1 margnal benefts of tranng per worker 1 A accrung to frms and, therefore, the demand for θ ( ρ) better traned workers. As n the prevous subsecton, ths occurs because more tranng reduces relatve prces and the senstvty of output (and profts) to prces s greater, the greater the elastcty of product demand. Hgher demand for tranng generates n turn hgher wages for traned labour, and a hgher supply of sklls. 0 Proceedng as n the secton 1.1 that s, takng nto account the entry condton, the frst-order condtons wth respect to employment and the symmetry of prces we obtan that θ = 1/ ρ, whch used n [17] yelds: A τ = ( 1 ρ) ξ + η [18] We conclude from ths that Corollary 1 holds ndependently of the fact that tranng s specfc or general. Therefore, any emprcal evdence showng that ant-compettve regulaton reduces tranng s consstent both wth the stuaton descrbed n sub-secton 1.1, where frms tran and bear the tranng costs and wages are set by barganng, 1 and wth an alternatve settng wth no barganng where workers bear the tranng costs and frms hre sklled labour from the market.. The Emprcal Model In the emprcal applcaton, we nvestgate whether changes n regulaton affect tranng, measured n our data as the proporton TP of workers recevng tranng durng a defned perod of tme. Ths measure gves us an ndcaton of the proporton of tme an average worker spends beng traned. If the quantty of tranng depends solely on the tme spent on t, and workers are homogeneous, the measure TP s also proportonal to the amount of tranng gven to every worker, the varable used n the theoretcal model. 3 Equatons [14] n the case of frm specfc tranng and [18] n 0 Subject to the assumpton of small hrng costs, our model s close to the model developed by Gaudalupe (007) to explan the effect of product market deregulaton on skll prema n the Unted Kngdom. 1 Or, wth no barganng power, workers are pad ther outsde opton. Bassann et al. (007), for example, show that there s a very strong correlaton between the proporton of employees that are traned n a gven year and average hours of tranng per employee. 3 In a prevous verson of ths paper (Bassann and Brunello, 007), we explctly dstngush between traned and untraned workers n the theoretcal model. In that case, tranng s defned as a 0-1 event both n the theoretcal and n the 18

20 the case of general tranng generate a map from entry costs ρ to tranng ntensty τ, and therefore TP. To the extent that the relatonshp between entry costs ρ and the degree of strngency of regulatory barrers s monotonc, ths map s also from regulatory barrers R to tranng TP, and n the absence of data on entry costs but wth nformaton on regulaton we can estmate the relatonshp between R and TP. Alternatvely, snce n the long-run equlbrum entry costs are equal to (net) real profts per unt of output, we can use a measure of proftablty, such as the Lerner ndex, to proxy entry costs. In ths case, the relatonshp between deregulaton and tranng conssts of two components: the effect of proftablty on tranng and the effect of product market regulaton on proftablty (entry costs). However, the problem wth any measure of proftablty s that t s endogenous, as productvty shocks whch affect tranng also nfluence profts. Fortunately, and lettng asde poltcal economy consderatons, entry regulaton can be assumed to be exogenous and to affect tranng only through proftablty so that the degree of strngency of regulatory barrers can be used as an nstrument for the measure of proftablty. 4 Our regulatory ndcators and proftablty measures vary by sector, country and over tme. Therefore, we collapse our data on tranng and addtonal controls at the same level of aggregaton and estmate the followng emprcal counterpart of the theoretcal model: TP ct = λ 0 + λ1 Xct + λyct + εct [19] where X s a vector of controls, whch ncludes average age, educaton and frm sze, Y s the selected measure of regulaton or proftablty, the subscrpt s for the ndustry, c s for the country and t s for tme. The lnear specfcaton n [19] can be problematc when the dependent varable s fractonal (see Wooldrdge, 001). Followng Papke and Wooldrdge (1996), we assume that the condtonal mean s a logt functon G of the ndependent varables and consder the followng transformed generalzed lnear model (GLM) as an alternatve to [19]: emprcal applcaton, and ts ntensty s measured by the partcpaton rate. Theoretcal results are smlar to those dscussed n the current verson, at the prce of greater complexty. 4 Regulaton mght be endogenous f deregulaton tends to occur where productvty growth or nnovaton are greater and tranng s correlated wth these varables (see e.g. Duso and Röller, 003). Although we beleve that ths s unlkely to serously affect estmates, we partally control for ths channel by addng to some of our specfcatons, as addtonal covarates, R&D ntensty, productvty levels and growth and the nvestment rate. 19

21 TP ct ( λ + λ Xct + λ Yct ) + εct = G 0 1 [0] that we estmate usng a quas-maxmum lkelhood estmator (QMLE), where the quas-lkelhood functon s the bnary choce log lkelhood. 5 We postulate that the error term s as follows ε = ξ + ξ + ξ + ω ct c t ct ct where ξ c s a country by ndustry effect, ξ t s an ndustry by tme effect, ξ ct s a country by tme effect, and ω ct s a standard dsturbance. We control for these unobserved effects by ncludng n the specfcaton country by sector, country by year, and sector by year dummes. The country by sector dummes capture cross country dfferences n the structure of each ndustry, ncludng dfferences n the parameters σ, δ and A; the sector by year effects capture the tme varyng dfferences n trend growth between affected ndustres (treated group) and ndustres not affected drectly by deregulaton (control group); the country by year dummes absorb country-specfc macroeconomc effects, countrywde changes n polcy (notably tranng polcy and naton-wde regulaton, on whch we have no data - see below) as well as changes n the routng of the questonnare and/or the exact formulaton of the tranng queston. Our key nterest les n estmatng the coeffcent λ, whch measures the relatonshp between product market regulaton and tranng. A negatve estmate of λ would suggest that a negatve relatonshp between regulaton and tranng prevals, consstent wth the theoretcal model of secton 1. One mght argue, however, that the tranng concept developed n the model corresponds to steady state tranng stocks, whle we have specfed our emprcal model n terms of tranng flows. Although ths argument s questonable, we can observe that, gven that tranng stocks and tranng flows are lkely to be postvely correlated, the model can be re-specfed n terms of the tranng stock TS by smply substtutng t for TP n equaton [19]. In a senstvty analyss, we construct tranng stocks from 5 Papke and Wooldrdge (1996) show that QMLE estmators of ths knd yeld consstent estmates of equaton [0] ndependently of any assumpton on the error term, for whch a robust varance estmator can be easly devsed. In addton, n contrast to the more classcal WLS estmaton of a lnear model wth log-odds transformaton of the dependent varable, the GLM specfcaton does not requre adjustment for boundary values (such as zeros) and can be estmated when fractonal data are obtaned by sample averages n samples of unknown sze that cannot therefore be used to construct weghts, as s our case. 0

22 tranng flows by followng a methodology smlar to Cont (005) and Dearden et al. (006). In partcular, we assume a common deprecaton rate ( β = ) and a steady state rate of tranng growth g equal to the sample average growth rate of tranng flows, 6 and reconstruct ntal condtons under the assumpton that steady state growth occurs at the begnnng of the sample, whch mples TP /( + g = TS 1 β ) 0, where TP 1 s the tranng flow n the frst perod and TS 0 the tranng stock n the ntal perod. Fnally, tranng stocks after mssng years are constructed by assumng steady state growth n those years. Specfcatons [19] and [0] assume that, condtonal on the vector X, product market regulaton varables are the only nsttutonal varables that can vary by country, year and sector, and that nsttutonal confoundng factors are fully accounted for by the combnaton of country by year, country by sector and sector by year dummes. Whle ths s plausble, we cannot rule out the possblty that varables measurng labour market nsttutons at the same level of detal as regulaton varables do affect tranng. If ths s so, falure to account for these effects could erroneously attrbute them to changes n product market regulaton. Therefore, we also experment wth specfcatons that augment the vector X wth avalable measures of labour market nsttutons. 3. Data We use three man sources of data: a) an OECD database on tranng and other labour market varables; b) OECD regulatory ndcators for seven non-manufacturng ndustres (electrcty, gas, ar transport, road transport, ralways, post and telecommuncatons); c) addtonal sector-level nformaton on output, physcal captal and other controls avalable n the OECD STAN Famly databases and the companon 60-ndustry database of the Gronngen Growth and Development Centre. The OECD database on tranng s drawn from the EU Labour Force Surveys. It contans nformaton on tranng and a number labour market varables (namely age, gender, educaton, parttme/full-tme status, occupaton, ndustry, frm-sze, tenure, whether the contract s temporary or permanent, whether the actvty s n the country of resdence, partcpaton n tranng, type of tranng and tranng duraton) for employed workers of 3 European countres from 1995 to 00 (wth many mssng values, correspondng to countres and years where questons on tranng were not 6 In the steady state, flows and stocks grow at the same rate. In country/sector unts where a decrease of tranng flows s observed, the steady state growth rate s set to zero. Alternatve measures of tranng stocks are dscussed n Secton 4. 1

23 admnstered or data on tranng are unrelable). Data have been collected n the second quarter of each year (March n most countres). Quanttatve varables (such as tenure or frm sze) are dvded nto categores (see the appendx for more detals). As regards to age, we dspose of categores coverng fve-year ntervals, but reconstruct an ordnal varable by applyng to all observatons n each category the mean age of the category. Data are sem-aggregated nsofar as organzed by cells. Each cell corresponds to a combnaton of categores. Avalable cells cover all non-empty combnatons wth one category for each varable. Populaton weghts are reported for each cell. Tranng data refer to partcpaton n any educaton or tranng course n the 4 weeks precedng the ntervew (1 week for France). Informaton on the type of tranng and ts length s avalable but often mssng. For ths reason, we do not use t. In order to avod that ntal and close-to-retrement educaton confound the nformaton on workplace tranng, we lmt our analyss to full-tme employees wth at least 1 month of tenure, aged between 5 and 54 years, and workng n ther country of resdence. Descrptve statstcs on tranng are avalable n the Appendx. We collapse our data on tranng and selected other labour market varables (educaton, age, gender and frm sze) at the level of sectors. Industres are avalable at the dgt level of the NACE rev.1 classfcaton 7 for most countres and years n manufacturng. In servces, they are avalable at a slghtly more dsaggregated level than 1 dgt of NACE rev. 1. However, snce only NACE 1970 s avalable for certan country-year pars, we are oblged to aggregate a few ndustres n order to construct our sector-level database. The fnal lst of ndustres s avalable n the Appendx. We have access to detaled OECD ndcators of ant-compettve product market regulaton n seven or 3 dgt non-manufacturng ndustres. Data are avalable for 1 OECD countres on an annual bass and span from 1975 to 003. These ndcators refer to sector-specfc entry barrers, publc ownershp, the market share of the domnant player(s) when relevant (n the telephone, gas and ralroad sectors), vertcal ntegraton n network ndustres and prce controls when relevant (n the road freght ndustry). Outsde the scope of these ndcators are naton-wde aspects of regulatons applyng to all ndustres, such as admnstratve barrers to entrepreneurshp (admnstratve barrers on start-ups, general features of the lcensng and permt system, etc...), snce these data are not avalable n tmeseres n the OECD database. Avalable ndcators vary between 0 and 6 from the least to the most regulated. Entry barrers cover legal lmtatons on the number of companes and rules on vertcal ntegraton of network 7 At the dgt level, ths classfcaton corresponds to the ISIC rev. 3, wth extremely few exceptons.

24 ndustres. A value of 0 corresponds to free entry. By contrast, a value of 6 apples when entry s severely restrcted. Publc ownershp measures the share of equty owned by central or muncpal governments, and takes a value of 0 n the case of no equty and a value of 6 n the case of full ownershp. All other ndcators are smlarly defned 8. Followng Alesna et al. (005) we use the avalable nformaton to construct tme-seres ndcators of regulatory barrers for three aggregate ndustres (utltes, transport, and communcaton servces), for whch we have tranng data. Ths method nvolves two steps. Frst, separate ndcators of barrers to entry, publc ownershp, market structure, vertcal ntegraton and prce controls for each of the seven ndustres are averaged to obtan two coarser (and partally alternatve) ndcators: BEVI, whch summarzes barrers to entry (comprsng legal restrctons and vertcal ntegraton) and REGNO, whch ncludes all dmensons except publc ownershp. As our model apples explctly to barrers to entry we expect BEVI to be related to tranng. The same mght apply to REGNO nsofar as the presence of prce controls and the absence of barrers to concentraton can, to a certan extent, be seen as addtonal barrers to start-ups. Second, the same ndcators for the three more aggregated ndustres are obtaned by smple averagng the values of the correspondng sub-ndustres. Once the two ndcators of regulaton are matched to our tranng data we obtan 309 country by sector by tme non-mssng observatons concernng three (typcally regulated) servce ndustres for 15 European countres and a maxmum of 8 years. 9 Yet, these ndustres account for a small share of total employment (about 7.5% n 00). Moreover, n the event that reforms n these three sectors have occurred almost smultaneously, the effect of the varaton n regulaton on tranng ncdence rsks to be swept away once country per year dummes are ncluded n the emprcal analyss. To crcumvent ths problem, we add manufacturng ndustres to our dataset. For these ndustres, regulaton concerns essentally admnstratve burdens, lmtatons to foregn drect nvestment as well as barrers to trade, at least n European countres. Now, only the last two barrers can be consdered to be sector-specfc. But for them, due to the comng nto acton of the Sngle Market Programme (SMP) n 199, t can be assumed that ther tme profle s flat snce at least 1994 for the 1 countres that were EU members n 199 (see e.g. Bottasso and Sembenell, 001). 30 The 8 More detals on these ndcators are avalable from Ncolett et al. (001), Alesna et al. (005) and Conway and Ncolett (006). 9 Snce the exact month of each regulatory reform s not known and mght well be subsequent to the second quarter of the correspondng year, each regulatory ndcator s lagged one year. 30 Bottasso and Sembenell (001) report that, on average, 75% of the measures mpled by the SMP agreement were already transposed nto natonal legal systems at the tme when the SMP came nto acton, and that vrtually all measures were transposed shortly after. 3