Pigou first suggested in 1912, that there exists an externality in the provision of training by private firms because workers can, once they have been trained, quit one firm for another. This was the rationale behind the Industrial Training Act of 1964. Firms had to contribute a fixed sum each year to a centralized fund, but then received grants for training new workers. In Discussion Paper No. 1360, Research Fellow Alison Booth and Gylfi Zoega look at the effect of quitting on the number of workers trained under conditions of uncertainty about future productivity, when workers have both firm-specific and industry-specific skills. The authors challenge the under-investment results of Margaret Stevens (1995), alternatively called the ‘quitting externality’ – referring to the fact that when a trained worker quits, the services are lost to the firm but not to society.

This literature has not taken into account uncertainty about future productivity and the resulting option value of waiting. Booth and Zoega find that a higher quit rate can, when future productivity is uncertain, increase rather than decrease the number of workers trained by reducing the irreversibility of the training investment and hence making it less risky. A high quit rate makes the hiring decision less risky because it reduces the likelihood that the firm will be stuck with a worker once his/her employment is no longer profitable. The excess return required by firms before they hire an additional worker is reduced. This offsets some or all of the underinvestment effect, depending on the existence of some firing restrictions. These restrictions can be imposed by the government in the form of mandated redundancy payments or be caused by the existence of trade unions which aggressively fight lay-offs. Lastly, most public enterprises are unable to shed workers since life-employment is guaranteed. The main policy implication of this paper is that one has to look simultaneously at the nature of training, quit rates, the level of uncertainty about future demand/productivity and firing restrictions before concluding that the quitting externality causes underinvestment in training.


Quitting Externalities with Uncertainty about Future Productivity
Alison L Booth and Gylfi Zoega