Human capital

Human capital

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Human capital
is the stock of competencies, knowledge and personality attributes embodied in the ability to perform labor so as to produce economic value. It is the attributes gained by a worker through education and experience. Many early economic theories refer to it simply as workforce, one of three factors of production
Factors of production
In economics, factors of production means inputs and finished goods means output. Input determines the quantity of output i.e. output depends upon input. Input is the starting point and output is the end point of production process and such input-output relationship is called a production function...

, and consider it to be a fungible resource -- homogeneous and easily interchangeable. Other conceptions of this labor dispense with these assumptions.

Background


Justin Slay defined four types of fixed capital (which is characterized as that which affords a revenue or profit without circulating or changing masters). The four types were:
  1. useful machines, instruments of the trade;
  2. buildings as the means of procuring revenue;
  3. improvements of land;
  4. the acquired and useful abilities of all the inhabitants or members of the society.


Adam Smith
Adam Smith
Adam Smith was a Scottish social philosopher and a pioneer of political economy. One of the key figures of the Scottish Enlightenment, Smith is the author of The Theory of Moral Sentiments and An Inquiry into the Nature and Causes of the Wealth of Nations...

 defined human capital as follows:

“Fourthly, of the acquired and useful abilities of all the inhabitants or members of the society. The acquisition of such talents, by the maintenance of the acquirer during his education, study, or apprenticeship, always costs a real expense, which is a capital fixed and realized, as it were, in his person. Those talents, as they make a part of his fortune, so do they likewise that of the society to which he belongs. The improved dexterity of a workman may be considered in the same light as a machine or instrument of trade which facilitates and abridges labor, and which, though it costs a certain expense, repays that expense with a profit.”.


Therefore, Smith argued, the productive power of labor are both dependent on the division of labor:

"The greatest improvement in the productive powers of labour, and the greater part of the skill, dexterity, and judgement with which it is any where directed, or applied, seem to have been the effects of the division of labour".


There is a complex relationship between the division of labor and human capital.

Origin of the term


A. W. Lewis is said to have begun the field of Economic Development and consequently the idea of human capital when he wrote in 1954 the "Economic Development with Unlimited Supplies of Labour." The term "human capital" was not used due to its negative undertones until it was first discussed by Arthur Cecil Pigou
Arthur Cecil Pigou
Arthur Cecil Pigou was an English economist. As a teacher and builder of the school of economics at the University of Cambridge he trained and influenced many Cambridge economists who went on to fill chairs of economics around the world...

: "There is such a thing as investment in human capital as well as investment in material capital. So soon as this is recognised, the distinction between economy in consumption and economy in investment becomes blurred. For, up to a point, consumption is investment in personal productive capacity. This is especially important in connection with children: to reduce unduly expenditure on their consumption may greatly lower their efficiency in after-life. Even for adults, after we have descended a certain distance along the scale of wealth, so that we are beyond the region of luxuries and "unnecessary" comforts, a check to personal consumption is also a check to investment.

The use of the term in the modern neoclassical
Neoclassical economics
Neoclassical economics is a term variously used for approaches to economics focusing on the determination of prices, outputs, and income distributions in markets through supply and demand, often mediated through a hypothesized maximization of utility by income-constrained individuals and of profits...

 economic
Economics
Economics is the social science that analyzes the production, distribution, and consumption of goods and services. The term economics comes from the Ancient Greek from + , hence "rules of the house"...

 literature dates back to Jacob Mincer
Jacob Mincer
Jacob Mincer , was a father of modern labor economics. He was Joseph L. Buttenwiser Professor of Economics and Social Relations at Columbia University for most of his active life.-Biography:...

's article "Investment in Human Capital and Personal Income Distribution" in The Journal of Political Economy in 1958. Then T.W. Schultz who is also contributed to the development of the subject matter. The best-known application of the idea of "human capital" in economics is that of Mincer and Gary Becker
Gary Becker
Gary Stanley Becker is an American economist. He is a professor of economics, sociology at the University of Chicago and a professor at the Booth School of Business. He was awarded the Nobel Memorial Prize in Economic Sciences in 1992, and received the United States' Presidential Medal of Freedom...

 of the "Chicago School" of economics
Chicago school (economics)
The Chicago school of economics describes a neoclassical school of thought within the academic community of economists, with a strong focus around the faculty of The University of Chicago, some of whom have constructed and popularized its principles...

. Becker's book entitled Human Capital, published in 1964, became a standard reference for many years. In this view, human capital is similar to "physical means of production
Capital (economics)
In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...

", e.g., factories and machines: one can invest in human capital (via education, training, medical treatment) and one's outputs depend partly on the rate of return on the human capital one owns. Thus, human capital is a means of production
Means of production
Means of production refers to physical, non-human inputs used in production—the factories, machines, and tools used to produce wealth — along with both infrastructural capital and natural capital. This includes the classical factors of production minus financial capital and minus human capital...

, into which additional investment yields additional output. Human capital is substitutable, but not transferable like land, labor, or fixed capital.

Modern growth theory sees human capital as an important growth factor. Further research shows its relevance for democracy or AIDS.

Competence and capital


The introduction is explained and justified by the unique characteristics of competence (often used only knowledge). Unlike physical labor (and the other factors of production), competence is:
  • Expandable and self generating with use: as doctors get more experience, their competence base will increase, as will their endowment of human capital. The economics of scarcity is replaced by the economics of self-generation.
  • Transportable and shareable: competence, especially knowledge, can be moved and shared. This transfer does not prevent its use by the original holder. However, the transfer of knowledge may reduce its scarcity-value to its original possessor.


Example
An athlete can gain human capital through education and training, and then gain capital through experience in an actual game. Over time, an athlete who has been playing for a long time will have gained so much experience (much like the doctor in the example above) that his human capital has increased a great deal. For example: a point guard gains human capital through training and learning the fundamentals of the game at an early age. He continues to train on the collegiate level until he is drafted. At that point, his human capital is accessed and if he has enough he will be able to play right away. Through playing he gains experience in the field and thus increases his capital. A veteran point guard may have less training than a young point guard but may have more human capital overall due to experience and shared knowledge with other players.

Competence, ability, skills or knowledge?
Often the term "knowledge" is used. "Competence" is broader and includes thinking ability ("intelligence") and further abilities like motoric and artistic abilities. "Skill" stands for narrow, domain-specific ability. The broader terms "competence" and "ability" are interchangeable.

Knowledge equity (= knowledge capital - knowledge liability) plus emotional capital (= emotional capital - emotional liability) equals goodwill or immaterial/intangible value of the company.

Intangible value of the company (goodwill) plus (material) equity equals the total value of the company.

Marxist analysis



In some way, the idea of "human capital" is similar to Karl Marx
Karl Marx
Karl Heinrich Marx was a German philosopher, economist, sociologist, historian, journalist, and revolutionary socialist. His ideas played a significant role in the development of social science and the socialist political movement...

's concept of labor power
Labor power
Labour power is a crucial concept used by Karl Marx in his critique of capitalist political economy. He regarded labour power as the most important of the productive forces of human beings. Labour power can be simply defined as work-capacity, the ability to do work...

: he thought in capitalism
Capitalism
Capitalism is an economic system that became dominant in the Western world following the demise of feudalism. There is no consensus on the precise definition nor on how the term should be used as a historical category...

 workers sold their labor power in order to receive income (wages and salaries). But long before Mincer or Becker wrote, Marx pointed to "two disagreeably frustrating facts" with theories that equate wages or salaries with the interest on human capital.
  1. The worker must actually work, exert his or her mind and body, to earn this "interest." Marx strongly distinguished between one's capacity to work, Labor power
    Labor power
    Labour power is a crucial concept used by Karl Marx in his critique of capitalist political economy. He regarded labour power as the most important of the productive forces of human beings. Labour power can be simply defined as work-capacity, the ability to do work...

    , and the activity of working.
  2. A free worker cannot sell his human capital in one go; it is far from being a liquid asset, even more illiquid than shares and land. He does not sell his skills, but contracts to utilize those skills, in the same way that an industrialist sells his produce, not his machinery. The exception here are slaves, whose human capital can be sold, though the slave does not earn an income himself.


An employer must be receiving a profit
Profit (economics)
In economics, the term profit has two related but distinct meanings. Normal profit represents the total opportunity costs of a venture to an entrepreneur or investor, whilst economic profit In economics, the term profit has two related but distinct meanings. Normal profit represents the total...

 from his operations, so that workers must be producing what Marx (under the labor theory of value
Labor theory of value
The labor theories of value are heterodox economic theories of value which argue that the value of a commodity is related to the labor needed to produce or obtain that commodity. The concept is most often associated with Marxian economics...

) perceived as surplus-value, i.e., doing work beyond that necessary to maintain their labor power
Labor power
Labour power is a crucial concept used by Karl Marx in his critique of capitalist political economy. He regarded labour power as the most important of the productive forces of human beings. Labour power can be simply defined as work-capacity, the ability to do work...

. Though having "human capital" gives workers some benefits, they are still dependent on the owners of non-human wealth for their livelihood.

The term appears in Marx's article in the New-York Daily Tribune article "The Emancipation Question," January 17 and 22, 1859, although there the term is used to describe humans who act like a capital to the producers, rather than in the modern sense of "knowledge capital
Knowledge capital
Knowledge capital is a concept which asserts that ideas have intrinsic value which can be shared and leveraged within and between organizations. Knowledge capital connotes that sharing skills and information is a means of sharing power...

" endowed to or acquired by humans.

Importance of Human Capital


The concept of Human capital has relatively more importance in labour-surplus countries. These countries are naturally endowed with more of labour due to high birth rate under the given climatic conditions. The surplus labour in these countries is the human resource available in more abundance than the tangible capital resource. This human resource can be transformed into Human capital with effective inputs of education, health and moral values. The transformation of raw human resource into highly productive human resource with these inputs is the process of human capital formation. The problem of scarcity of tangible capital in the labour surplus countries can be resolved by accelerating the rate of human capital formation with both private and public investment in education and health sectors of their National economies. The tangible financial capital is an effective instrument of promoting economic growth of the nation. The intangible human capital, on the other hand, is an instrument of promoting comprehensive development of the nation because human capital is directly related to human development, and when there is human development, the qualitative and quantitative progress of the nation is inevitable . This importance of human capital is explicit in the changed approach of United Nations
United Nations
The United Nations is an international organization whose stated aims are facilitating cooperation in international law, international security, economic development, social progress, human rights, and achievement of world peace...

  towards comparative evaluation of economic development of different nations in the World economy. United Nations publishes Human Development Report
Human Development Report
The Human Development Report is an annual milestone publication by the Human Development Report Office of the United Nations Development Programme .-History:...

  on human development in different nations with the objective of evaluating the rate of human capital formation in these nations. The statistical indicator of estimating Human Development in each nation is Human Development Index
Human Development Index
The Human Development Index is a composite statistic used to rank countries by level of "human development" and separate "very high human development", "high human development", "medium human development", and "low human development" countries...

 (HDI). It is the combination of "Life Expectancy Index", "Education Index
Education Index
This article contains information based on the pre-2010 Human Development Reports. The HDI and its education component have changed in 2010.The United Nations publishes a Human Development Index every year, which consists of the Education index, GDP Index and Life Expectancy Index...

" and "Income Index". The Life expectancy index reveals the standard of health of the population in the country; education index reveals the educational standard and the literacy ratio of the population; and the income index reveals the standard of living of the population. If all these indices have the rising trend over a long period of time, it is reflected into rising trend in HDI. The Human Capital is developed by health, education and quality of Standard of living
Standard of living
Standard of living is generally measured by standards such as real income per person and poverty rate. Other measures such as access and quality of health care, income growth inequality and educational standards are also used. Examples are access to certain goods , or measures of health such as...

. Therefore, the components of HDI viz, Life Expectancy Index, Education Index and Income Index are directly related to Human Capital formation within the nation. HDI is indicator of positive correlation between human capital formation and economic development. If HDI increases, there is higher rate of human capital formation in response to higher standard of education and health. Similarly, if HDI increases, per capita income of the nation also increases. Implicitly, HDI reveals that higher the human capital formation due to good standard of health and education, higher is the per capita income of the nation. This process of human development is the strong foundation of a continuous process of economic development of the nation for a long period of time. This significance of the concept of Human capital in generating long-term economic development of the nation cannot be neglected. It is expected that the Macroeconomic policies of all the nations are focussed towards promotion of human development and subsequently economic development. Human Capital is the backbone of Human Development and economic development in every nation.

Cumulative Growth of Human Capital


Human capital is distinctly different from the tangible monetary capital due to the extraordinary characteristic of human capital to grow cumulatively over a long period of time. The growth of tangible monetary capital is not always linear due to the shocks of business cycle
Business cycle
The term business cycle refers to economy-wide fluctuations in production or economic activity over several months or years...

s. During the period of prosperity, monetary capital grows at relatively higher rate while during the period of recession
Recession
In economics, a recession is a business cycle contraction, a general slowdown in economic activity. During recessions, many macroeconomic indicators vary in a similar way...

 and depression, there is deceleration of monetary capital. On the other hand, human capital has uniformly rising rate of growth over a long period of time because the foundation of this human capital is laid down by the educational and health inputs. The current generation is qualitatively developed by the effective inputs of education and health. The future generation is more benefited by the advanced research in the field of education and health, undertaken by the current generation. Therefore, the educational and health inputs create more productive impacts upon the future generation and the future generation becomes superior to the current generation. In other words, the productive capacity of future generation increases more than that of current generation. Therefore, rate of human capital formation in the future generation happens to be more than the rate of human capital formation in the current generation. This is the cumulative growth of human capital formation generated by superior quality of manpower in the succeeding generation as compared to the preceding generation. In India, rate of human capital formation has consistently increased after Independence due to qualitative improvement in each generation. In the second decade of 21st century, the third generation of India's population is active in the workforce of India. This third generation is qualitatively most superior human resource in India. It has developed the service sector of India with the export of financial services
Financial services
Financial services refer to services provided by the finance industry. The finance industry encompasses a broad range of organizations that deal with the management of money. Among these organizations are credit unions, banks, credit card companies, insurance companies, consumer finance companies,...

, software services , tourism services and improved the Invisible balance
Invisible balance
The invisible balance or balance of trade on services is that part of the balance of trade that refers to services and other products that do not result in the transfer of physical objects. Examples include consulting services, shipping services, tourism, and patent license revenues. This figure is...

 of India's Balance of payments. The rapid growth of Indian economy in response to improvement in the service sector is an evidence of cumulative growth of Human Capital in India.

Debates about the concept


Some labor economists have criticized the Chicago-school theory, claiming that it tries to explain all differences in wages and salaries in terms of human capital.

The concept of human capital can be infinitely elastic, including unmeasurable variables such as personal character or connections with insiders (via family or fraternity). This theory has had a significant share of study in the field proving that wages can be higher for employees on aspects other than human capital. Some variables that have been identified in the literature of the past few decades include, gender and nativity wage differentials, discrimination in the work place, and socioeconomic status. However, Austrian economist Walter Block theorizes that these variables are not the cause of gender wage gap. Thomas J. DiLorenzo summarizes Block' s theory well: "marriage affects men and women very differently in terms of their future earning abilities, and is therefore an important cause of the male/female wage gap". Block alleges that there is no wage gap between unmarried men and women, but married men salaries are usually more than married women. These wages, he contends, are the opportunity cost of being a mother and raising children.

The prestige of a credential
Credentialism
Credentialism is a term used to describe a primary reliance on credentials for purposes of conferring jobs or social status. In some jobs, employers require a diploma, academic degree, security clearance, or professional license for a job which does not require the specific training that is part of...

 may be as important as the knowledge gained in determining the value of an education. This points to the existence of market imperfections
Market failure
Market failure is a concept within economic theory wherein the allocation of goods and services by a free market is not efficient. That is, there exists another conceivable outcome where a market participant may be made better-off without making someone else worse-off...

 such as non-competing groups and labor-market segmentation. In segmented labor markets, the "return on human capital" differs between comparably skilled labor-market groups or segments. An example of this is discrimination
Discrimination
Discrimination is the prejudicial treatment of an individual based on their membership in a certain group or category. It involves the actual behaviors towards groups such as excluding or restricting members of one group from opportunities that are available to another group. The term began to be...

 against minority or female employees.

Following Becker, the human capital literature often distinguishes between "specific" and "general" human capital. Specific human capital refers to skills or knowledge that is useful only to a single employer or industry, whereas general human capital (such as literacy) is useful to all employers. Economists view firm specific human capital as risky, since firm closure or industry decline lead to skills that cannot be transferred (the evidence on the quantitative importance of firm specific capital is unresolved).

Human capital is central to debates about welfare, education
Education
Education in its broadest, general sense is the means through which the aims and habits of a group of people lives on from one generation to the next. Generally, it occurs through any experience that has a formative effect on the way one thinks, feels, or acts...

, health care
Health care
Health care is the diagnosis, treatment, and prevention of disease, illness, injury, and other physical and mental impairments in humans. Health care is delivered by practitioners in medicine, chiropractic, dentistry, nursing, pharmacy, allied health, and other care providers...

, and retirement
Retirement
Retirement is the point where a person stops employment completely. A person may also semi-retire by reducing work hours.Many people choose to retire when they are eligible for private or public pension benefits, although some are forced to retire when physical conditions don't allow the person to...

..

Mobility between nations


Educated individuals often migrate from poor countries to rich countries seeking opportunity. This movement has positive effects for both countries: capital-rich countries gain an influx in labor, and labor rich countries receive capital when migrants remit money home. The loss of labor in the old country also increases the wage rate for those who do not emigrate. When workers migrate, their early care and education generally benefit the country where they move to work. And, when they have health problems or retire, their care and retirement pension
Pension
In general, a pension is an arrangement to provide people with an income when they are no longer earning a regular income from employment. Pensions should not be confused with severance pay; the former is paid in regular installments, while the latter is paid in one lump sum.The terms retirement...

 will typically be paid in the new country.

African nations have invoked this argument with respect to slavery, other colonized peoples have invoked it with respect to the "brain drain
Brain drain
Human capital flight, more commonly referred to as "brain drain", is the large-scale emigration of a large group of individuals with technical skills or knowledge. The reasons usually include two aspects which respectively come from countries and individuals...

" or "human capital flight" which occurs when the most talented individuals (those with the most individual capital
Individual capital
Individual capital, also known as human capital, comprises inalienable or personal traits of persons, tied to their bodies and available only through their own free will, such as skill, creativity, enterprise, courage, capacity for moral example, non-communicable wisdom, invention or empathy,...

) depart for education or opportunity to the colonizing country (historically, Britain
United Kingdom
The United Kingdom of Great Britain and Northern IrelandIn the United Kingdom and Dependencies, other languages have been officially recognised as legitimate autochthonous languages under the European Charter for Regional or Minority Languages...

 and France
France
The French Republic , The French Republic , The French Republic , (commonly known as France , is a unitary semi-presidential republic in Western Europe with several overseas territories and islands located on other continents and in the Indian, Pacific, and Atlantic oceans. Metropolitan France...

 and the U.S.). Even in Canada
Canada
Canada is a North American country consisting of ten provinces and three territories. Located in the northern part of the continent, it extends from the Atlantic Ocean in the east to the Pacific Ocean in the west, and northward into the Arctic Ocean...

 and other developed nations, the loss of human capital is considered a problem that can only be offset by further draws on the human capital of poorer nations via immigration. The economic impact of immigration to Canada
Economic impact of immigration to Canada
The economic impact of immigration is an important topic in Canada. While the immigration rate has declined sharply from its peak early in the 20th century, Canada still holds the title of accepting more immigrants per capita than any other country....

 is generally considered to be positive.

During the late 19th and early 20th centuries, human capital in the United States became considerably more valuable as the need for skilled labor came with newfound technological advancement. The 20th century is often revered as the "human capital century" by scholars such as Claudia Goldin. During this period a new mass movement toward secondary education paved the way for a transition to mass higher education. New techniques and processes required further education than the norm of primary schooling, which thus led to the creation of more formalized schooling across the nation. These advances produced a need for more skilled labor, which caused the wages of occupations that required more education to considerably diverge from the wages of ones that required less. This divergence created incentives for individuals to postpone entering the labor market in order to obtain more education. The “high school movement” had changed the educational system for youth in America. With minor state involvements, the high school movement started at the grass-roots level, particularly the communities with the most homogeneous populations. As a year in high school added more than ten percent to an individual’s income, post-elementary school enrollment and graduation rates increased significantly during the 20th century. The U.S. system of education was characterized for much of the 20th century by publicly funded mass secondary education that was open and forgiving, academic yet practical, secular, gender neutral, and funded by small, fiscally independent districts. This early insight into the need for education allowed for a significant jump in US productivity and economic prosperity, when compared to other world leaders at the time. It is suggested by several economists, that there is a positive correlation between high school enrollment rates and GDP per capita. Less developed countries have not established a set of institutions favoring equality and role of education for the masses and therefore have been incapable of investing in human capital stock necessary for technological growth.

The rights and freedom of individuals to travel and opportunity, despite some historical exceptions such as the Soviet bloc and its "Iron Curtain", seem to consistently transcend the countries in which they are educated. One must also remember that the ability to have mobility with regards to where people want to move and work is a part of their human capital. Being able to move from one area to the next is an ability and a benefit of having human capital. To restrict people from doing so would be to inherently lower their human capital.

This debate resembles, in form, that regarding natural capital
Natural capital
Natural capital is the extension of the economic notion of capital to goods and services relating to the natural environment. Natural capital is thus the stock of natural ecosystems that yields a flow of valuable ecosystem goods or services into the future...

.

Classification


Human capital is an intangible asset as it is not owned by the firm that employs it. Basically, human capital arrives at 9am and leaves at 5pm. Human capital when viewed from a time perspective consumes time in one of key activities:
  1. Knowledge (activities involving one employee),
  2. Collaboration (activities involving more than 1 employee),
  3. Processes (activities specifically focused on the knowledge and collaborative activities generated by organizational structure - such as silo impacts, internal politics, etc.) and
  4. Absence (annual leave, sick leave, holidays, etc.).

Risk


When human capital is assessed by activity based costing via time allocations it becomes possible to assess human capital risk. Human capital risk occurs when the organization operates below attainable operational excellence levels. For example, if a firm could reasonably reduce errors and rework (the Process component of human capital) from 10,000 hours per annum to 2,000 hours with attainable technology, the difference of 8,000 hours is human capital risk. When wage costs are applied to this difference (the 8,000 hours) it becomes possible to financially value human capital risk within an organizational perspective.

Human capital risk accumulates in four primary categories:
  1. Absence activities (activities related to employees not showing up for work such as sick leave, industrial action, etc.). Unavoidable absence is referred to as Statutory Absence. All other categories of absence are termed "Controllable Absence";
  2. Collaborative activities are related to the expenditure of time between more than one employee within an organizational context. Examples include: meetings, phone calls, instructor led training, etc.;
  3. Knowledge Activities are related to time expenditures by a single person and include finding/retrieving information, research, email, messaging, blogging, information analysis, etc.; and
  4. Process activities are knowledge and collaborative activities that result due to organizational context such as errors/rework, manual data transformation, stress, politics, etc.

See also


  • Capital (economics)
    Capital (economics)
    In economics, capital, capital goods, or real capital refers to already-produced durable goods used in production of goods or services. The capital goods are not significantly consumed, though they may depreciate in the production process...

  • Capital accumulation
    Capital accumulation
    The accumulation of capital refers to the gathering or amassing of objects of value; the increase in wealth through concentration; or the creation of wealth. Capital is money or a financial asset invested for the purpose of making more money...

  • Capitalize or expense
  • Cross-cultural capital
    Cross-cultural capital
    In management and organizational studies disciplines, cross-cultural capital is the aggregate set of knowledge, skills, abilities and psychological dispositions that gives individuals competitive advantage in interacting, working, and managing in culturally diverse environments...

  • Human Capital Management
  • Human development theory
    Human development theory
    Human development theory is a theory that merges older ideas from ecological economics, sustainable development, welfare economics, and feminist economics. It seeks to avoid the overt normative politics of most so-called "green economics" by justifying its theses strictly in ecology, economics and...

  • Labor power
    Labor power
    Labour power is a crucial concept used by Karl Marx in his critique of capitalist political economy. He regarded labour power as the most important of the productive forces of human beings. Labour power can be simply defined as work-capacity, the ability to do work...

  • Theodore Schultz
    Theodore Schultz
    Theodore William Schultz was the 1979 winner of the Nobel Memorial Prize in Economic Sciences....



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