Human Capital definition and importance

Human Capital is a measure of the skills, education, capacity and attributes of labour which influence their productive capacity and earning potential.

According to the OECD, human capital is defined as:

“the knowledge, skills, competencies and other attributes embodied in individuals or groups of individuals acquired during their life and used to produce goods, services or ideas in market circumstances”.

  • Individual human capital – the skills and abilities of individual workers
  • Human capital of the economy – The aggregate human capital of an economy, which will be determined by national educational standards.

Measuring human capital

For statistical purposes, human capital can be measured in monetary terms as the total potential future earnings of the working age population. (However, this only captures part of human capital and is a limited measure)

human-capitalHuman Capital at UK ONS

The decline in UK human capital reflects the rise in unemployment and fall in real wages during this period. It should be noted relying on potential earnings is a limited view of human capital. Earnings don’t necessarily reflect accurately all aspects of human capital. The OECD consider different ways to measure human capital taking a range of indicators.

Factors that determine human capital

  • Skills and qualifications
  • Education levels
  • Work experience
  • Social skills – communication
  • Intelligence
  • Emotional intelligence
  • Judgement
  • Personality – hard working, harmonious in an office
  • Habits and personality traits
  • Creativity. Ability to innovate new working practices/products.
  • Fame and brand image of an individual. e.g. celebrities paid to endorse a product.
  • Geography – Social peer pressure of local environment can affect expectations and attitudes.

Human capital in primary and secondary sector

In agriculture and manufacturing, human capital was easier to measure. The human capital of an assembly line worker could be measured in simple terms of productivity – e.g. the number of widgets produced per hour. In mining, human capital may be strongly related to physical strength and quantity of coal produced per day.

Human capital in tertiary sector/knowledge economy

The tertiary/service sector has a greater variety of jobs, which require different skills. These skills and qualities are often more difficult to measure regarding output. For example, the human capital of a teacher, cannot be measured by university degree and A-Levels. The best academics may lack some teaching skills – like empathy, the ability to inspire and command a class.

In a job, such as management, important characteristics will be factors such as interpersonal skills, ability to work in a team and the creativity to problem solve.

In other words, as the economy has developed the concept of human capital has also broadened to include a greater variety of skills and traits of capital.

Since the 1960s/70s, human capital has become a more popular economic concept as the emerging ‘knowledge economy‘ makes greater use of a wider range of human capital.

How to increase human capital

Specialisation and division of labour. Specialisation allows workers to concentrate on specific tasks and increased specialisation of skills. (Though specialisation can also lead to boring, repetitive jobs and limited skill development of workers.)

“The greatest improvement in the productive powers of labour.. seem to have been the effects of the division of labour.”

– Adam Smith

Education. Basic education to improve literacy and numeracy has an important implication for a basis of human capital.

Vocational training. Direct training for skills related to jobs, electrician, plumbing nursing. A skilled profession requires particular vocational training.

A climate of creativity. An education which enables children to think outside the box can increase human capital in a way that ‘rote learning’ and an impressive accumulation of facts may not.

Infrastructure. The infrastructure of an economy will influence human capital. Good transport, communication, availability of mobile phones and the internet are very important for the development of human capital in developing economies.

Competitiveness. An economy dominated by state monopolies is likely to curtail individual creativity and entrepreneurs. An environment which encourages self-employment and the creation of business enables greater use of potential human capital in an economy.

Importance of human capital

Structural unemployment. Individuals whose human capital is inappropriate for modern employers may struggle to gain employment. A major issue in modern economies is that rapid deindustrialisation has left many manual workers, struggling to thrive in a very different labour market.

Quality of employment. In the modern economy, there is increasing divergence between low-skilled, low-paid temporary jobs (gig economy). High-skilled and creative workers have increased opportunities for self-employment or good employment contracts.

Economic growth and productivity. Long-term economic growth depends increasingly on improvements in human capital. Better educated, innovative and creative workforce can help increase labour productivity and economic growth.

Human capital flight. An era of globalisation and greater movement of workers has enabled skilled workers to move from low-income countries to higher income countries. This can have adverse effects for developing economies who lose their best human capital.

Limited raw materials. Economic growth in countries with limited natural resources, e.g. Japan, Taiwan and South East Asia. Rely on high-skilled, innovative workforce adding value to raw materials in the manufacturing process.

Sustainability ”what we leave to future generations; whether we leave enough resources, of all kinds, to provide them with the opportunities at least as large as the ones we have had ourselves” (UN, 2012)

Different views on Human Capital

Theodore Schultz “Investment in human capital” (1961) was an early proponent of theory. He stated:

“Although it is obvious that people acquire useful skills and knowledge, it is not obvious that these skills and knowledge are a form of capital, that this capital is in substantial part a product of deliberate investment”

Gary Becker “Human Capital” (1964) In his view, human capital, is determined by education, training, medical treatment, and is effectively a means of production. Increased human capital explains the differential of income for graduates. Human capital is also important for influencing rates of economic growth.

Howard Gardener – different types of human capital. Gardener emphasised the different types of human capital. One could increase education, but be a poor manager. A successful entrepreneur may have no education. Human capital is not unidimensional.

Schultz/Nelson-Phelps – ability to adapt. Human capital should be looked at from the ability to adapt. Can workers adapt to a changing labour market? A labour market which is shifting from full-time manual work in manufacturing to flexible work in the service sector.

Spence View – Observable signs of human capital like education are essentially a signalling function.

Evaluation of human capital

Social upbringing. A sociologist like Pierre Bourdieu argues that human capital is strongly related to social upbringing. This influences cultural, social and symbolic forms of capital. For example, UK society dominated by Old Etonians and Oxbridge graduates who gain confidence and social capital from having the right social networks.

Signalling. Related to the social capital of going to the right school, is the idea that what constitutes human capital is often just ‘signalling’. For example, gaining a degree from Oxbridge improves status in the workforce and enables a higher salary for the graduate. However, three years of studying a degree in modern history/PPE may give only a small amount of knowledge directly related to work environment.

Discrimination. Differences in wages and job opportunities are not necessarily due to differences in human capital, but the result of discrimination, labour market imperfections or non-monetary benefits of jobs.

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Further Reading on Human Capital

2 thoughts on “Human Capital definition and importance

  1. Human capital is said to bring about development in various ways . However the situation in most developing countries might prove otherwise. Closure of industries has left many with industrial skills idle. Developing countries can not fully exploit the abilities and skills of human capital as they do not have enough jobs to offer. Thus the developing countries have become a human capital generating machine for the developed world

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