A Good Worker is Hard to Find: Skills Shortages in New Zealand Firms

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1 A Good Worker is Hard to Find: Skills Shortages in New Zealand Firms Penny Mok, Geoff Mason, Philip Stevens and Jason Timmins Ministry of Economic Development Occasional Paper 12/05 April 2012 ISBN: (PDF) ISBN: (online)

2 Ministry of Economic Development Occasional Paper 12/05 A Good Worker is Hard to Find: Skills Shortages in New Zealand Firms Date: April 2012 Author: Penny Mok Geoff Mason Treasury National Institute of Economic and Social Research, London Philip Stevens Ministry of Economic Development Jason Timmins Department of Labour Acknowledgements The authors would like to thank Belinda Buxton, Rosie Byford, Elizabeth Chisholm, Hilary Devine, Sid Durbin, Richard Fabling, Bette Flagler, Julia Gretton, Hamish Hill, Bill Kaye-Blake, Peter Nunns, Meighan Ragg, Lynda Sanderson, Steven Stillman, Richard White and participants in the Industry Training Federation, the Labour, Employment and Work, the New Zealand Association of Economists, and the New Zealand Centre for SME Research conferences (and others whom we have neglected to mention). We acknowledge two lots of funding from the Cross- Departmental Research Funding for the production of IBULDD (and thence the LBD) and for the Impact of Skills on New Zealand Firms project. Contact: Occasionalpapers@med.govt.nz Disclaimer The views, opinions, findings, and conclusions or recommendations expressed in this Occasional Paper are strictly those of the author(s). They do not necessarily reflect the views of the Ministry of Economic Development or the Department of Labour, Treasury or the National Institute of Economics and Social Research. The Ministry takes no responsibility for any errors or omissions in, or for the correctness of, the

3 information contained in these occasional papers. The paper is presented not as policy, but with a view to inform and stimulate wider debate. Access to the data used in this paper was provided by Statistics NZ in accordance with security and confidentiality provisions of the Statistics Act Only people authorised by the Statistics Act 1975 are allowed to see data about a particular, business or organisation. The results in this paper have been confidentialised to protect individual businesses from identification. The results are based in part on tax data supplied by Inland Revenue to Statistics NZ under the Tax Administration Act This tax data must be used only for statistical purposes, and no individual information is published or disclosed in any other form, or provided back to Inland Revenue for administrative or regulatory purposes. Any person who had access to the unit-record data has certified that they have been shown, have read and have understood section 81 of the Tax Administration Act 1994, which relates to privacy and confidentiality. Any discussion of data limitations or weaknesses is not related to the data's ability to support Inland Revenue's core operational requirements.

4 Abstract This paper examines the determinants of firms skill shortages, using a speciallydesigned survey, the Business Strategy and Skills (BSS) module of the Business Operations Survey. We combine the BSS module with additional data on firms in the Statistics New Zealand s prototype Longitudinal Business Database (LBD). We focus on vacancies that were hard-to-fill because the applicants lacked the necessary skills, qualification or experience - which we define as skill-related reasons (skill shortage vacancies). We also contrast these with vacancies that were hard-tofill for non-skill-related reasons. JEL Classification: J24, J31, L60 Keywords: skill shortages, hard-to-fill vacancies, Business Operations Survey, Heckman Selection model i

5 Executive Summary Skills are an important determinant of the economic performance of people, firms, industries and economies. Shortages of skilled labour directly constrain production and prevent firms from meeting demand and using available inputs efficiently. They inhibit innovation and the use of new technologies. This may have longer-term impacts on the way firms do business, in terms of their location, size, structure, production methods and product strategy. In this paper we have examined factors relating to firms skill shortages. Our focus has been on vacancies that were hard-to-fill because the applicants lacked the necessary skills, qualification or experience what we have defined as skill shortage vacancies (SSVs). We have also contrasted these with vacancies that were hard-tofill for reasons other than the skills of applicants. Worker turnover is a basic fact of economic life. In any given year one in eight workers leaves their employer. Searching for new staff is, therefore, a position most businesses find themselves in, regardless of their situation. Almost half of businesses find some of these vacancies hard-to-fill and more than a third experience difficulties in finding workers with the required skills, qualifications or experience they need. We have examined patterns of skill shortage vacancies using an econometric technique that allows us to account, in part, for the interrelationship between the likelihood of a firm posting a vacancy and for those vacancies being hard-to-fill for skill-related reasons. Large firms are more likely to have vacancies they have more workers and so the chance of at least one of them leaving is consequently higher. However, larger firms do not appear to find it more difficult to source workers with the required skills than smaller firms, once we account for other characteristics. As we might expect, when firms output grows, the need to seek additional staff also grows. However, this is only in the years the firm is expanding. Expanding sales is not a good predictor of future additional staff requirements. Businesses can experience skill shortages internally or externally. A shortage in the skills it requires can manifest itself: (a) in terms of the ability of its existing staff to do ii

6 their job; or (b) in terms of its ability to find appropriately skilled workers through recruitment. We have found evidence that these two phenomena co-exist. Businesses experiencing internal skill gaps are also more-likely to have skill shortage vacancies. We also find evidence of persistence in this relationship; businesses experiencing internal skill gaps are also more likely to have SSVs in the following year. Businesses have a make or buy option when it comes to skills. If they cannot source the skills internally or externally, they can up-skill existing or new workers through training. Firms training choices are the subject of a companion paper to this (Mason et al., 2012). In this paper, we find that firms who undertake training are more likely to have vacancies, suggesting that their response to skill shortages is likely to be a mixture of recruitment and up-skilling strategies. Our results confirm earlier work that highlights the importance of two distinctions: First, it is important to distinguish between firms general recruitment activity and it having skill shortage vacancies. Second, we must distinguish between firms experiencing recruitment difficulties related to skills and those for other reasons (such as the firm not offering good enough pay and conditions). Failing to account for this may cause us to misdiagnose the problem and will therefore undermine the appropriateness of any policy prescription. In any market there will be a number of potential customers that cannot purchase all they would wish because they are unwilling or unable to pay the market price. This does not mean that the market is malfunctioning. There is an important question for researchers and policymakers to ask before interpreting reports of unfilled vacancies of any kind, and of SSVs in particular, as a skills problem. This question is: Why do businesses that cannot fill a vacancy not simply raise the wages they are offering? There a number of reason why firms may not be able to do so. First, it may be because the firm cannot afford to pay any more. If this is the case, the problem is not the labour market or the education system, but the firm s own productivity. Firms that that undertake activities associated with high productivity are likely to both have a higher demand for skills and be more able to afford to pay skill premia. Second, the supply of labour takes a long time to adjust. Because of the length of time required to educate and train skilled workers, it takes a long time for changes in iii

7 wages to influence changes in skill acquisition (particularly if we are relying on the rather indirect mechanism of changes in relative wages influencing the choices of students at school) and immigration is restrained by, among other things, legal barriers and the costs of relocation. We have found that the businesses that feel the applicants they are attracting do not have the required skills, qualifications or experience are those that are paying higher wages. The fact that businesses that pay higher wages than others in the same industry and region are actually more likely to experience SSVs suggests that raising wages is not sufficient to fill these vacancies. In contrast, when we focus on vacancies that are hard-to-fill for reasons other than skill, paying higher wages does appear to be a successful policy to fill vacancies. Firms that pay higher relative wages are less likely to have non-skill-related hard-to-fill vacancies. The implication of this is that SSVs and NSRs are different phenomena. One important issue researchers have to confront when undertaking analysis of this type is that of causality. It is one thing to establish a statistical regularity a correlation between firm characteristics, activities or environment and an outcome such as external skill shortages. It is another thing to interpret this as a causal relationship. In this paper, we have uncovered some clear statistical regularities. These are consistent we with certain predictions we have discussed in this paper and provide us with useful information to aid our understanding of how the landscape of skills in New Zealand and, in particular, we done this from the perspective what businesses are looking for, rather than what the education and training system has provided. iv

8 Table of Contents Abstract... i Executive Summary... ii Table of Contents... v List of Figures... vii List of Tables... vii 1. Introduction Background Skills and Economic Performance Skills and Firm Performance Labour Turnover and Vacancies Skill Shortages Skills and the Labour Market Firm s Responses to Skill Shortages Summary Data and Preliminary Analysis Business Operations Survey (BOS) Vacancies Hard-to-fill vacancies Skill and non-skill-related shortage vacancies Internal skill gaps Method Basic econometric model Selection equation The likelihood of vacancies Probability of SSVs Results Using contemporaneous variables Using lagged variables Skill and non-skill related hard-to-fill vacancies Summary and Conclusions References Appendix A1. Data Appendix A1.1 BOS Variables Module A ( ) Module B Innovation (2007) Module C Employment Practices (2006) Module C Business Strategy and Skills A1.2 LEED/PAYE Data A1.3 Other LBD Data (AES, BAI, and IR10) v

9 Appendix A2. Comparison of hard-to-fill vacancies in Module C with recruitment difficulties in Module A vi

10 List of Figures Figure 1 Skill shortages and Hard-to-fill vacancies in Green et al. (1998)... 7 Figure 2 Vacancies, hard-to-fill and skill shortage vacancies List of Tables Table 1 Vacancies, hard-to-fill, skill and non-skill-related shortage vacancies, % Table 2 Businesses reporting vacancies, % Table 3 Businesses reporting hard-to-fill vacancies, % Table 4 Year-to-year rank correlation between reported recruitment difficulties Table 5 Skill-related reasons for hard-to-fill vacancies, by size Table 6 Existing staff with skills required to do their job Table 7 Principal component factor analysis of business strategy variables Table 8 Factor loadings (pattern matrix) and unique variances Table 9 Principal component factor analysis of 2007 business strategy Table 10 Factor loadings (pattern matrix) and unique variances Table 11 Principal component factor analysis of census variables Table 12 Rotated factor analysis Table 13 Rotated factor loadings (pattern matrix) and unique variances Table 14 Results - SSVs - Contemporaneous variables - Selection equation Table 15 Results SSVs Contemporaneous variables Outcome equation Table 16 Results - SSVs - Lagged variables - Selection equation Table 17 Results - SSVs - Lagged variables - Outcome equation Table 18 Results Different definitions of dependent variable Table 19 Staff occupation/role variables Table 20 Weighted counts of firms reporting levels of difficulty recruiting new staff in Module A by Module C hard-to-fill vacancy response vii

11 A Good Worker is Hard to Find: Skills Shortages in New Zealand Firms 1. Introduction Skills are an important determinant of the economic performance of people, firms, industries and economies 1. Shortages of skilled labour directly constrain production and prevent firms from meeting demand and using available inputs efficiently (Haskel and Martin, 1993a; Stevens, 2007). Indirectly, skill shortages inhibit innovation and the use of new technologies. This may have longer-term impacts on the way firms do business, in terms of their location, size, structure, production methods and product strategy (Mason and Wilson, 2003; Durbin, 2004; Mason, 2005). The success of policies to enable the emergence and performance of successful businesses depends upon having a workforce with the appropriate skills. There are, however, concerns that New Zealand is experiencing a shortage of workers with particular skills 2. If New Zealand is to raise productivity and improve its international competitiveness, it is important to understand whether skill shortages do indeed exist, how they manifest themselves and develop policies to address them. In this paper we investigate skill shortages deriving from recruitment difficulties at firm level. That is, vacancies that are hard-to-fill because applicants do not have the 1 See Card (1999) or Dickson and Harmon (2011) for an overview of the results on the individual returns to education and skills, Abowd, Kramarz, Margolis (1999) or Haskel, Hawkes and Periera (2005) for evidence on the relationship between firm performance and skills, Kneller and Stevens (2005) present international evidence for skills at the industry level in OECD economies and Stevens and Weale (2004) or Madsen (2010) discuss evidence on the relationship between education levels and growth. 2 Skills shortage hits agricultural science, Dominion Post, 13/01/12, Half of Kiwi companies facing skill shortages, NZ Herald, 30/11/11, Academic warns of major skills shortage, Waikato Times, 4/3/11 1

12 skill, qualifications or experience the business requires. In order to carry out this analysis, we make use of a specially-designed survey, the Business Strategy and Skills (BSS) module of the Business Operations Survey (BOS) We combine this with information from other sections of the current and previous years BOS and data from the prototype Longitudinal Business Database (LBD). The LBD includes information from tax and survey-based financial data, merchandise and services trade data and a variety of sample surveys on business practices and outcomes. This allows us to link the responses of the BSS module to a wealth of information on firms to inform our analysis. The rest of this paper is as follows. In section 2 we discuss some of the issues that influence the interrelationship between the skills of the workforce and the performance of businesses. In section 3 we describe our data and present some descriptive information on New Zealand firms experiences of skills. We set out our empirical model in section 4 and our results in section 5. Section 6 concludes. 2. Background Skills and Economic Performance Human capital (and education in particular) has been found to be an important determinant of economic development and explanator of international differences in aggregate economic growth or productivity (Barro and Sala-i-Martín, 1995; Stevens and Weale, 2004; Kneller and Stevens, 2005; Madsen, 2010). There is a large literature examining the links between the availability of skills and the performance of firms. These range from detailed case studies (see Keep, Mayhew and Corney, 2002, for a summary of those undertaken by the UK National Institute for Economic and Social Research) to econometric analysis using firm-level data and industry level measures of skill shortages (e.g. Haskell and Martin, 1993b, 2001; Haskel, Martin and Periera, 2005; Stevens, 2007). In this section, we consider the importance of skills for firms, how labour markets match the skills of workers to their uses in firms, and how firms respond to skills shortages. We also consider what we mean by a skill shortage. Can such a thing exist in a well-functioning economy? 2.1. Skills and Firm Performance There are essentially two elements to the link between skills and firm performance. First, skills represent a basic input into the firm s production technology. Individuals 2

13 with higher skills have more human capital and so produce greater output. There is a large literature that consistently finds positive private and social returns to skill and education in particular (Card, 1999; Psacharopoulos and Patrinos, 2004; McMahon, 2004). Higher skill levels do not only increase firm productivity through the direct impact on the worker s own productivity. They also create synergies with other productive inputs, such as other workers, physical and knowledge capital, R&D or new technologies. An obvious example of how skills enhance the performance of other workers is the skills of managers, who organise and shape production. The quality of management in businesses is an important predictor of business performance across a number of dimensions in many countries (Bloom and Van Reenen, 2007, 2010; 2011), including New Zealand (UTS, 2009). Another way skilled labour increases the productivity of other workers is through what are known as knowledge spillovers (Arrow, 1962; Battu, Belfield and Sloane, 2004; Audretsch and Feldman, 2004). Spillovers occur when other workers pick up these skills through observation, interaction or tuition. These spillovers can occur within the firm and across the boundaries of the firms through direct relationships (i.e. with suppliers and customers) or through geographic proximity (Glaeser, Kallal, Scheinkman and Shleifer, 1992; Audretsch and Feldman, 2004). For a long time it has been suggested that skilled labour is more complementary with capital than unskilled labour (Griliches, 1969; Duffy, Papageorgiou, and Perez- Sebastian, 2004). Many capital goods (e.g. computers) require skills to operate (Autor, Katz and Krueger, 1998; Morrison-Paul and Siegel, 2001; Falk, 2004). Autor, Levy and Murname (2003) found that over three decades, computer capital has replaced workers undertaking routine or repetitive manual and cognitive tasks and complemented those doing non-routine problem-solving and communications tasks. As well as physical capital, higher skill levels enable a workforce to deal with the current technology and, moreover, they enable the firm to better adapt to new technology (Machin and Van Reenen, 1998). For economists, technology is taken generally to include the means whereby inputs are brought together to produce outputs, including organisational and product strategy. Mason (2005) found that the 3

14 ability of firms in a number of industries to execute high value business strategies was contingent on the skills of their workforce. Work such as Abowd, Haltiwanger, Lane McKinney and Sandusky (2007) finds a strong positive empirical relationship between advanced technology and skill. Skills are required not only for the creation of new technology, but also both for its dispersion and implementation (Rosenberg, 1972; Lane and Lubatkin, 1998; Hall and Khan, 2003; Kneller and Stevens, 2006). Investing in skills Both workers and firms have an incentive to increase productivity through investing in skills, but their incentives are different. Individuals have an incentive to invest in skill formation because this enables them to function better in the economy and society. Crucially, they provide the basis for them to earn an income. Firms also have an incentive to increase the skills of their workforce because this enables them to perform more tasks or increase the productiveness with which they perform existing tasks. Because the skills embedded in workers can be increased by investing in them, economists use the term human capital. Firms do not have the incentive to invest in all types of human capital equally. General human capital is of value to all employers, whereas specific human capital is valuable only to specific firms or groups of firms (Becker, 1962, 1994; Stevens, 1994) 3. Firms will tend to under-provide training of all skills that have some generality to them (i.e. they are of use to other firms) because of the risks of staff leaving or being poached; there is a risk that they will pay the costs and other firms will get the benefits. Because they may not reap all of the rewards staff may move elsewhere or be poached by other firms firms may invest less in such training that would be socially optimal 4. The likelihood of staff using recently acquired human capital by moving elsewhere will depend of the outside options they have, in particular the wages on offer. 3 The specificity of skills may in also be determined by the structure of the market. Acemoglu and Pischke (1999) argue that certain skills might be potentially useful to other firms (i.e. general) may become specific because of market imperfections. For example, if there were only one producer in a sector a particular skill might only be of use to them, whereas if a number of firms were operating in the same area they could be competing for the same labour. 4 Both firms and individuals may under invest in skills and education if there are externalities. This might include agglomeration benefits (such as knowledge dispersion), matching externalities, benefits in terms of lower crime, higher levels of political engagement and health. 4

15 This is where labour differs from other factors of production. It is not tied to the firm, beyond the terms of its contractual relationship. It can decide to take its skill and use them elsewhere Labour Turnover and Vacancies Labour turnover is a basic fact of economic life (Davis, Halitwanger and Schuh, 1996; Davis, Faberman and Haltiwanger, 2006, 2010). For example, from the September to the December quarter of 2010, total employment in New Zealand expanded from 1,777,110 to 1,810,580, an increase of 33, This change was dwarfed by the almost half a million workers either leaving or starting jobs from which it resulted. Because of the dynamic nature of the labour market, we must be careful not to equate vacancies with job creation. Firms can have positive values for both hires and separations (Davis, Faberman and Haltiwanger, 2006). In the December 2010 quarter, 12.7% of workers in New Zealand became separated from their jobs 6. This is not merely due to firms shrinking (what is called job destruction ). The total job destruction in the December 2010 quarter was 90,890 barely two-fifths of the total worker separations. Firms will post vacancies for two reasons: First, to replace staff who have quit, retired or been fired; Second, to fill new roles that have been created by the expansion of the firm. These two sources of vacancies are likely to have different causes. Voluntary separations may be higher in good times (as the likelihood of alternative employment increases), but involuntary separations may be lower (as firms seek to reduce employment) (Pissarides, 2000). New roles are more likely to be created when a firm is expanding 7. Given this discussion, we might reasonably expect the number of vacancies generally increase with the number of employees. However, some work has found vacancy rates to decline with firms size (e.g. Holtz, 1994). Note that our discussion relates to vacancy rates. Our data is a binary variable stating whether or not a firm posts a vacancy. We would generally expect 5 Source: Statistics New Zealand Linked-Employer Employee Database. Data downloaded from: 6 Source: Authors calculations based on LEED data. This separation rate is calculated as Worker separations in the December 2010 quarter divided by the average of Total filled jobs in the December and September quarters. 7 For a textbook description of the standard dynamic model of labour demand, see Nickell (1996). 5

16 phenomena that increase the numbers or rate of vacancies to also increase the probability of the firm reporting at least vacancy Skill Shortages The primary focus of this paper is on difficulties firms face in filling roles for reasons related to the qualifications or experience of applicants what we call skill shortage vacancies. However, this is not the only way in which skill shortages can manifest. Much early work in this area did not distinguish between the types of skill shortage. It focussed on skill shortages as a whole and their impacts. This was driven in part by the data that were available to researchers. For example, in the UK, the Confederation of British Industry has collected information on whether firms output was limited by shortages of skilled labour since the early 1970s 8. However, it has become clear that it is important to distinguish between shortages of skills in existing workers and shortages of staff in the labour market with appropriate skills (Green, Machin and Wilkinson, 1998; Mason and Wilson, 2003). These have been called internal skill gaps and external skill gaps, respectively (e.g. Forth and Mason, 2004) 9. The primary focus of this paper is on external skill gaps. When examining external skill gaps, it is important to be clear what we are measuring. As Green et al., (1998) point out, we must be careful not to simply equate them with vacancies that are hard-to-fill. As we shall see in section 3.3, there are many reasons why vacancies may be hard-to-fill. These reasons range from the conditions of work to the fact that firms are simply not paying the market wage; not all of them are skill-related. Because of this, authors such as Mason and Stevens (2003) have focussed on the subset of vacancies that are hard-to-fill for skill-related reasons; specifically, by examining the reasons for vacancies being hard-to-fill and only considering those that relate to a lack of qualifications and/or experience in applicants. This is the approach that informed the design of the relevant sections of the Business Strategy and Skills module of the BOS 2008, and one that underlies our analysis in this paper. 8 This data has been used as an industry-level measure of shortages of skilled workers by Haskel and Martin (1993a), (1993b) and Stevens (2007). 9 Although, others have called skills deficiencies relating to the external labour market skills shortages and those applicable to a firm s existing workforce skills gaps (Schwalje, 2011). 6

17 We summarise the thinking on the various skill shortage concepts in Figure 1. Skill shortages can be internal to the firm, what we call internal skill gaps (ISG), or external, what we call skill shortage vacancies (SSV) 10. As well as SSVs, vacancies can be hard-to-fill for other reasons, what we call non-skill related vacancies (NSR). Figure 1 Skill shortages and Hard-to-fill vacancies in Green et al. (1998) Skill shortages Hard-to-fill vacancies ISG SSV NSR ISG = Internal Skill Gap; SSV = Skill Shortage Vacancy; NSR = Non-Skill-Related vacancy In order to understand why firms might find it difficult to source skilled labour, we need to consider the wider labour market. We turn our attention to this next Skills and the Labour Market Modern theories of labour markets are based around the ability of the market to match individuals to jobs (Pissarides, 2000; Petrongolo, and Pissarides, 2001; Mortensen, 2005). Trading in the labour market is not without cost. It takes time and money for businesses to advertise for and assess potential employees. It takes time and money for workers to search and apply for potential employment. We call these search costs. Furthermore, costs are incurred when incoming workers start in a new role; workers need to learn the specific tasks involved in the role and the 10 Of course some external skill gaps may not manifest themselves as SSVs because the firm may not bother to post vacancies they know they cannot fill. 7

18 employer has to learn about the specific abilities of their new employee 11. Another cost is the time a worker or a firm stays in a state awaiting a good match. Workers stay in less-preferable jobs or quit to unemployment while they wait for a better offer to come along. Firms either allocate a worker who is less aptly skilled to a role, or hold it open until the right worker comes along. We call these mismatch costs. Average search costs and mismatch costs are likely to be lower in larger labour markets; the more jobs and workers there are, the more likely it is that a good match will exist. Thus, businesses and workers operating in big cities, for example, will benefit from lower search costs, ceteris paribus. In part because of this, they are less likely to be stuck in bad worker-job matches (as the cost of exiting a low productivity match is much lower). These thick labour market agglomeration benefits can also come from co-location of economic activity with similar demand for skills; whilst there is more competition between firms for skilled labour, there will also be a greater supply (as workers with the appropriate skills are attracted to the area). Larger markets will be driven less by market frictions and more by the fundamental economic determinants of the productivity of the match (i.e. those that determine the productivity of the firm, the productivity of the worker and their complementarity). Firms ability to recruit and retain skilled staff will depend on local labour market conditions. These are typically summarised using the local unemployment rates or proportions of the population with particular qualifications (e.g. Mason and Stevens, 2003). The firm s ability to recruit new staff will also be affected by the outside wage. The opportunity cost of taking up a job at the firm for the worker is the value of the next best potential offer foregone. This will depend on the distribution of job offers and associated wages. These can be measured by average wage in similar jobs for example other jobs in that industry and/or region Firm s Responses to Skill Shortages How firms respond to labour market conditions will affect their performance. This is part of how firms compete. The obvious question to ask if a business cannot fill a vacancy is: why don t they just pay more? Here we discuss two reasons why this may not be possible. First, it may be because the firm cannot afford to pay any more. 11 For more on the training of incoming staff by New Zealand firms, see the companion paper to this (Timmins, et al., 2012). 8

19 In this case, the problem is not the labour market, but the firm s own productivity. Firms that that undertake activities associated with high productivity may well both have a higher demand for skills but also be more able to afford to pay skill premia. Firms with some degree of market power may not be more productive, but will be able to compete more aggressively for scarce inputs such as skilled staff. Second, the supply of labour takes a long time to adjust; it takes a long time for changes in wages to influence changes in skill acquisition (particularly if we are relying on the rather indirect mechanism of changes in relative wages influencing the choices of students at school) and immigration is restrained by, among other things, legal barriers and the costs of relocation. In an early study of apparent shortages of engineers and scientists, Arrow and Capron (1959) defined a skill shortage as a situation in which there are unfilled vacancies in positions where salaries are the same as those currently being paid in others of the same type and quality (1959: 301). Although they recognised that excess demand for skills in competitive labour markets should put upward pressure on salaries, Arrow and Capron suggested that, even in a competitive labour market, a steady increase in demand over time for skilled workers could produce a dynamic shortage if there were factors impeding rapid salary increases by employers such as delays in accepting the needs for such increases, the further time needed to implement them and a reluctance to incur increased salary costs for existing highskilled employees as well as new ones. At the same time supply responses to any salary improvements could be slowed down by the length of time required to educate and train skilled workers, as shown by Freeman (1971, 1976) in the case of engineers and scientists. Later studies have recognised that firms have a range of potential non-salary responses and coping mechanisms available to them when confronted by shortfalls in skills such as asking existing employees to work longer hours, making increased use of subcontractors or retraining existing staff to develop the skills in shortage. In a study based on data from the 1984 Workplace Industrial Relations Survey in the UK, Haskel and Martin (1993b) found no evidence of firms setting higher wages in response to difficulties in recruiting skilled workers. Indeed, they cited other UK survey evidence to suggest that salary responses were much less important than other means of addressing skilled recruitment difficulties. 9

20 Increased training provision is a potentially important non-salary response to external skill shortages which, like salary increases, should help alleviate the shortages in question rather than just help firms to cope with them 12. However, just as some firms may elect to live with external skill shortages for periods of time rather than incur the costs of raising salaries for new recruits with knock-on effects on existing salary differentials, some may also be reluctant to respond immediately to skill shortages by increasing training provision for existing workers. Such reluctance could reflect imperfect information about the costs and benefits of training versus other potential responses to skill shortages. But economic theory also points to other possible explanations for variation between firms in the extent and speed of training responses to different kinds of skill shortage. For example, Stevens (2007) suggests that the speed of firms adjustment behaviour is likely to vary inversely with the degree of competition in their particular labour markets for skills specific to their industries. More generally, resource- and knowledge-based theories of the firm suggest that heterogeneity of firms training responses to external skill shortages is to be expected. This is because the ability of any firm to provide training will be strongly conditioned by the specific resources and capabilities (such as management skills and training capacity) which it has accumulated over time (Teece, Pisano and Shuen, 1997; Eisenhardt and Martin, 2001; Teece, 2007) Summary This brief overview of the literature suggests a number of avenues for us to pursue in our analysis. First, we need to differentiate between firms general recruitment activity and it having skill shortage vacancies. Labour turnover is a basic fact of economic life. Fast-growing and large firms will be more likely to be seeking additional staff. Second, we need to distinguish between firms experiencing recruitment difficulties because of the availability of labour with the appropriate skills and those for other reasons, such as the firm merely not offering good enough pay and conditions. Failing to account for this may cause us to misdiagnose the problem and will therefore undermine the appropriateness of any policy prescription. In any 12 We examine the relationship between training and skill shortages in more detail in Mason, Mok, Stevens and Timmins, (2012). 10

21 market there will be a number of potential customers that cannot purchase all they would wish because they are unwilling or unable to pay the market price. Our quick survey of the literature suggests a number of patterns we might expect to see, or hypotheses we might test: Firms are more likely to suffer SSVs the greater the proportion of higher skilled staff they are looking for. Firms operating in tighter local labour markets will find it more difficult to fill roles. Firms with high-productivity strategies will have a higher demand for skills, but will be more able to pay skill premia. Firms with a degree of market power are likely to be more able to pay skill premia relative to their competitors. From a policy perspective, we wish to know whether these skill shortages are real or not. In any market, there will always be potential buyers who would wish to buy more, but are unwilling to do so at the current price. We know that labour markets do adjust supply to meet demand instantaneously; in the short run, the labour supply curve is likely to be almost vertical 13. Thus, a positive shock to demand (caused, for example, by a firm getting a large export order) is not likely to create an instantaneous increase in the supply of labour. In the short run, the effect may only be to increase wage inflation, as the firm outbids its competitors. In some cases the firm may source skilled workers internationally, but this takes time and resources. This suggests two alternative hypotheses, one for a labour market with some slack and one where the supply of labour is tight. If the market is working satisfactorily, firms that offer higher wages will be less likely to experience SSVs. If there are shortages of skilled labour and the firms with the highest demand for skills are those that are the most productive, it may be the firms that pay the highest wages that have SSVs. As we shall see below, because we only have a cross-section of data relating to SSVs, it is likely to be difficult to distinguish some of these phenomena. Nevertheless, we shall examine both the contemporaneous relationship and that between current SSVs and previous years firm characteristics. 13 there may of course be some economically inactive workers that are on the margins of entering the labour market, such as single parents for whom the costs of childcare may raise the reservation wage higher than their contemporaries 11

22 3. Data and Preliminary Analysis The data come from Statistics New Zealand s prototype Longitudinal Business Database (LBD). The LBD is built around the Longitudinal Business Frame (LBF), to which are attached, among other things, Goods and Services Tax (GST) returns, financial accounts (IR10) and aggregated Pay-As-You-Earn (PAYE) returns, all provided by the Inland Revenue Department (IRD). The full LBD is described in more detail in Fabling, Grimes, Sanderson and Stevens (2008) and Fabling (2009). The survey data considered in this chapter relate to the Business Operations Survey (BOS). The administrative data we use have four sources: the Linked Employer Employee Database (LEED), the Business Activity Indicator (BAI) dataset of GST returns, the Annual Enterprise Survey (AES) and IR10 forms. These are described in more detail in the Data Appendix Business Operations Survey (BOS) The Business Operation Survey (BOS) is an annual three part modular survey, which began in The first module is focussed on firm characteristics and performance. The second module alternates between biennial innovation and business use of ICT collections. The third module is a contestable module that enables specific policyrelevant data to be collected on an ad hoc basis 14. The BOS is conducted using twoway stratified sampling, with stratification on rolling-mean-employment (RME) and two-digit industry according to the ANZSIC system 15. The survey excludes firms with fewer than six RME and firms in the following industries: M81 Government Administration, M82 Defence, P92 Libraries, Museums and the Arts, Q95 Personal Services, Q96 Other Services, and Q97 Private Households Employing Staff. The 2008 survey achieved an 81.1% response rate (after adjusting for ceases), a total of 5,543 usable responses, representing a population of 36,075 firms. The BOS is something approaching best practice in such surveys internationally. It has removed replication of surveys 16 and thus reduces respondent load and makes 14 In 2005 and 2009 this was a Business Practices Module and in 2006 an Employment Practices Survey. The 2007 module was on International Engagement. 15 Note that there was some minor additional stratification conducted at the three-digit level. 16 Prior to the BOS, surveys tended to occur on a fairly ad hoc basis one assumes when policymakers were considering a particular issue. Thus there was a Business Practices Survey in 2001, an 12

23 sampling simpler. It is explicitly designed with a panel element; enabling more sophisticated analysis to be undertaken allowing us to better understand issues of causality and as the panel element increases dynamic issues 17. We do not use SNZ-imputed values in cases of item non-response where it is impossible to obtain them by simple edit rules (e.g. more than one expenditure categories are missing). When we discuss questions from the BOS, we shall denote the question by their module followed by their question number. So, for example, question 15 of Module C is denoted C15. When there are multiple categories of response in the same question (e.g. the different occupational groups in question C18, we use the code included on the form (e.g. C1801). Question numbers will relate to the 2008 BOS, unless otherwise specified. The Business Strategy and Skills (BSS) Module The Business Strategy and Skills (BSS) module of the 2008 Business Operations Survey was produced as part of the Impact of Skills on New Zealand Firms project. This project involved the Ministry of Economic Development, the Department of Labour, New Zealand Treasury and the Ministry of Research, Science and Technology and was partly funded by the Cross Departmental Research Pool. The module was designed by the project team in conjunction with Statistics New Zealand and Geoff Mason, from the National Institute of Economic and Social Research in London. In this section we consider all firms that report vacancies of any kind and focus in on hard-to-fill vacancies and what we call skill shortage vacancies (SSV). The skill shortage vacancies are defined as vacancies that were hard-to-fill because the applicants lacked the necessary skills, qualification or experience, which is a subset of hard-to-fill vacancies. As there are other reasons for having hard-to-fill vacancies, this allows us to distinguish the non-skill-related vacancies from the skill shortage vacancies. Innovation Survey in 2003 and a Business Finance Survey in (2004). Elements of each of these are considered either every year as part of the Business Performance Module (Module A) or every two or more years (i.e. the Innovation Module is run every other year and the Business Practices Module was run in 2005 and is scheduled to repeat in 2009). 17 The panel element is in fact larger than it first seems as there is considerable overlap with previous surveys, such as the 2001 Business Practices Survey (Fabling, 2007). 13

24 The overall percentages of firms reporting each type of vacancy are depicted as concentric circles in Figure 2. More detail on the construction and patterns of our measures of vacancies, skill and non-skill-related shortage vacancies are set out in the following sections. Figure 2 Vacancies, hard-to-fill and skill shortage vacancies Skill shortage vacancies (36%) Hard-to-fill vacancies (49%) Vacancies (77%) Figure shows the percentage of firms that report each type of vacancy Figures based in sample strata and weights Note that figures for the percentage of businesses with vacancies and hard-to-fill vacancies will not match the tables in the Statistics New Zealand Hot of the Press release because: (a) we use a slightly different sample and (b) we do not use imputed values 3.2. Vacancies Respondents were asked: During the last financial year, has this business had any vacancies? (C14). The first row of Table 1 summarises these data. We shall return to this table when we discuss hard-to-fill and skill shortage vacancies below. Overall, 76.6% of firms reported that they had posted a vacancy. As one might expect (given the greater number of employees), the likelihood of posting a vacancy increases with firm size. 14

25 Table 1 Vacancies, hard-to-fill, skill and non-skill-related shortage vacancies, % Business size E <20* 20 E<50 50 E<100 E 100 Overall Vacancies Hard-to-fill Vacancies Skill Shortage Vacancies Table shows percentage of firms reporting each type of vacancy Figures based in sample strata and weights Business size (E) is measured by rolling mean employment, or RME. Note that the figure for business size being fewer than 20 RME is not all firms in the total business population with fewer than 20 RME, but rather firms in the BOS sample. For more on these see the Data Appendix. Note that figures for number of businesses with vacancies and hard-to-fill vacancies will not match the tables in the Statistics New Zealand Hot of the Press release because: (a) we use a slightly different sample; (b) we do not use imputed values; and (c) we use rolling mean employment (RME) from the 2008 financial year, rather than We can break the reporting of vacancies down by occupation. Respondents that reported they had posted vacancies in the last year were asked a follow-up question: During the last financial year, how many vacancies has this business had for the following roles? (C15). The responses to this question are set out in Table 2. It is for clerical, sales and services workers that the greatest proportion of firms had vacancies, followed by labourers, production, transport or other workers. This reflects the greater number of staff in these occupations 18. This is not quite true across all firm sizes. Managers is the second most popular category for firms with more than one hundred employees (and also, marginally, for those with between 50 and 99 employees). 18 See Figure 6 of Stevens (2012) 15

26 Table 2 Businesses reporting vacancies, % Business size E<20* 20 E<50 50 E<100 E 100 Overall Managers Professionals Technicians and associate profs Tradespersons and rel. workers Clerical sales and service workers Labourers, production, transport or other workers All occupations Table presents data from questions C14: During the last financial year, has this business had any vacancies? and C15: During the last financial year, how many vacancies has this business had for the following roles? Table shows percentage of firms reporting each type of vacancy Figure for all occupations does not match that for Table 1 because some firms do not report the occupations of their vacancies Figures based in sample strata and weights Business size (E) is measured by rolling mean employment, or RME. * Note that the figure for business size being fewer than 20 RME is not all firms in the total business population with fewer than 20 RME, but rather firms in the BOS sample. For more on these see the Data Appendix. Note that figures for number of businesses with vacancies and hard-to-fill vacancies will not match the tables in the Statistics New Zealand Hot of the Press release because: (a) we use a slightly different sample; (b) we do not use imputed values; and (c) we use rolling mean employment (RME) from the 2008 financial year, rather than Hard-to-fill vacancies Respondents were asked: During the last financial year, was this business easily able to fill all vacancies with suitable applicants? (C16). Those who answered no to this question were classified as having a hard-to-fill vacancy. The second row of Table 1 (repeated at the bottom of Table 3) summarises these data. Well over half of the firms that have vacancies find them hard-to-fill (47.9% compared to 76.6%). Again, the probability of having a hard-to-fill vacancy increases with firm size, with almost three-quarters of firms with rolling mean employment of one hundred or more having hard-to-fill vacancies. 16

27 Table 3 Businesses reporting hard-to-fill vacancies, % Business size E<20* 20 E<50 50 E<100 E 100 Overall Managers Professionals Technicians and associate profs Tradespersons and related workers Clerical sales and service workers Labourers, production, transport or other workers All occupations Table presents data from questions C16 During this last financial year, was this business easily able to fill all vacancies with suitable applicants? and C18: Mark all that apply/ for this business, which roles were hard-tofill? Table shows percentage of firms reporting each type of vacancy Figure for all occupations does not match that for Table 1 because some firms do not report the occupations of their hard-to-fill vacancies Figures based in sample strata and weights Business size (E) is measured by rolling mean employment, or RME. Note that the figure for business size being fewer than 20 RME is not all firms in the total business population with fewer than 20 RME, but rather firms in the BOS sample. For more on these see the Data Appendix. Note that figures for number of businesses with vacancies and hard-to-fill vacancies will not match the tables in the Statistics New Zealand Hot of the Press release because: (a) we use a slightly different sample; (b) we do not use imputed values; and (c) we use rolling mean employment (RME) from the 2008 financial year, rather than Respondents that reported that they found some vacancies hard-to-fill were asked: For this business, which roles were hard-to-fill? (C18). Tradespersons and related workers were the occupations with which most businesses had recruitment difficulties (Table 3). This reflects a more even spread of hard-to-fill vacancies by firm size and hence the influence of the greater number of small (6-19 employees) firms. Managers were the role for which most large (100+) firms found difficult to fill vacancies. Given that managers represent a relatively small proportion of total staff, and one that has an important impact on firm performance (Bloom and Van Reenen, 2007, 2010; UTS, 2010), this is a worrying result. Comparison with Recruitment Difficulties in Module A In order to place these figures in context, it is useful to compare these results with the responses to a similar question that is asked in Module A. In a section on employment, firms are asked Over the last financial year, to what extent did this business experience difficulty in recruiting new staff for any of the following 17