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Human Capital: Definition, Examples, Pros & Cons

Written by Paul Boyce Posted in Microeconomics
Last Updated February 7, 2023

What is Human Capital

Human capital refers to the skills, habits, and other attributes each person possesses. In other words, the attributes that contribute to the production of the final economic output. Examples include factors such as education, training, intelligence, skills, health, and other factors that the employer values such as punctuality and interpersonal skills

For instance, a worker may have strong communication skills. The worker’s skills will have developed after years of dealing with thousands of customers – learning new and more effective ways in dealing with all types of customers. This is known as human capital.

Key Points

Human capital refers to the skills and expertise that allows the individual to do their task more productively.
Examples include: education, experience, and judgement.
Human capital is important as it helps workers do their job more effective and efficiently. In turn, this helps increase economic output and the overall wellbeing of a nation.

Human capital is not visible, nor is its value quantifiable. Yet it is crucial to a businesses long-term success. For example, a worker who has never used a computer before is unlikely to be as efficient in an office job as someone who has. In this instance, computing skills are classed as part of human capital. So a business may want to invest in bringing such a worker up to speed with the necessary training.

An employee’s skill, expertise, or personality are difficult to quantify, which is why the interview process is so important. It looks at the employee’s skill set, experience, and education, and values the human capital of each individual. In other words, it represents the individual’s economic value in a set profession.

Human Capital Theory

Human Capital theory originates from Adam Smith in 1776, with his book ‘The Wealth of Nations’. Gary Becker later went on to build upon Smith’s original theory who went on to coin the term ‘Human Capital’ in his 1964 book.

Becker highlighted a key similarity between what we normally consider as capital and ‘human capital’. He highlighted that traditional ‘capital’ such as stocks, steel plants, or assembly lines produce a yield – they are an investment that produces further income.

Becker went on to state that this could also be applied to ‘human capital’ such as schooling or on-the-job training. Both increase the economic output of the individual, so act in a similar way as a new steel plant. So the more education an individual has, the more they are capable of producing an earning, thereby increasing their worth to the firm.

Other Factors

Human Capital Theory also considers other factors such as medical care, migration, and information on prices, as human capital. The reasoning for such is that goods such as healthcare can prolong life or reduce the length of sickness.

Either way, it allows the recipient more time to work. For instance, an illness that may last a week could be reduced to only one day through anti-biotics. That’s four additional workdays gained, thereby increasing the economic output achieved.

Human Capital Examples

Human Capital can come under many various forms. Let us look at some examples below:

Abilities

We can think of ability in two ways: natural and developed. Natural ability refers to the abilities we have when we are born. For instance, Lionel Messi is known for his extraordinary ability in soccer. This was noticeable at a very young age and can be considered as human capital.

Though this natural ability, he has been able to make millions. Yet at the same time, this ability also needs hard work, good attitude, and nourishing. This is how the natural ability translates into a developed ability and in turn an economic advantage.

Creativity

It can be argued that creativity is not necessarily something that can be developed. In fact, it could be considered a natural ability. Some are more naturally creative than others. In turn, this can make some more productive in creative roles than others.

Education

This is the area which Human Capital Theory focuses on most greatly. As the wider population has learnt to read and write, the ability to learn and transfer knowledge has increased. For instance, the ability to read and write allows us to go through the internet and learn new skills.

However, education extends beyond reading and writing. It also includes the development of our analytical abilities. History for example requires writing techniques, whilst Science requires the development of research and investigation.

Experience

The more we experience the better we become at reacting the next time. For instance, someone who has fixed hundreds of electrical units is better equipped than someone who hasn’t.

The logic is that the more experiences we have, the more situations we face. So an electrician is far more capable if he has experience dealing with different types of units. When they are called out, they can recall their experiences to deal with a situation.

Judgement

As part of human capital, judgment refers to the decision people make in different situations. In part, this can be seen as natural. Yet judgment can be built upon and developed. For instance, making a judgment call on a yearly project could be improved if the employee has experienced the situation before.

Advantages of Human Capital Theory

1. Economic Growth

There is evidence to suggest that high levels of human capital correlate with higher levels of GDP. This is due to the fact that people are better educated, well trained, and therefore able to be more productive in the work place.

2. Employee Morale

When workers are better trained and more productive, it also benefits their moral and mental wellbeing. Getting a lot of work done and achieving something at the end of the day is far more rewarding.

3. Higher Income Levels

One of the key points of Human Capital Theory was that higher levels would increase income. For instance, higher levels of education boost income levels, with plenty of empirical research that emphasises this point. When people are able to read, write, and critically analyse, they are able to do complex tasks, and by extension, command a higher salary.

4. Higher rates of Civic Participation and Reduced Crime

More education, more training, and more skilled workers lead to better socioeconomic outcomes. This translates into improved quality of life for the majority of the population, which, in turn, helps reduce levels of crime. At the same time, a better-educated population is able to address other problems that occur in society.

Summary

Due to the wide-reaching benefits of Human Capital Theory, it has been used extensively to formulate not only government, but also company policy.

Highly trained workers are seen of greater importance and is why many private firms offer training schemes. In other words, it has, to an extent, revolutionised the workplace.

At the same time, governments have placed greater emphasis on education as a way of boosting economic growth. For example, in the USA, spending on education increased from $10,458 per student in 2000-2001, to $12,320 in 2015-16. That represents an 18 percent rise.

Limitations of Human Capital Theory

One of the main limitations of the Human Capital Theory is that it assumes greater education will always bring about higher income. In part, this has been backed up by studies. However, the theory is not comprehensive. Yes, higher education can lead to higher levels of income but is not the only variable in the equation.

Human Capital Theory includes factors such as health, skills, and experience. Yet it doesn’t consider other factors such as the role of status, network, or societal infrastructure. For instance, there are those who do not fit well into an academic environment. They may be the next Michael Jordan or Lionel Messi, yet are confined by the public schooling system. Providing an academic education to those who are not luted to such only prevents their true potential from flourishing.

Even though a greater level of academic education may result in higher wages, it may still be below the potential wage an individual could receive. For more information on Human Capital Theory, Ulster University offer a comprehensive overview in its technical report.

FAQs

What is human capital?

Human capital refers to the skills, qualities, or habbits that each person has. These can develop through training, education, and work experience. For instance, learning how to use Excel, Powerpoint, or other form of technology can be considered as human capital – they are new skills that help increase the efficiency of production.

What is an example of human capital?

One example of human capital is education. Through education, we are able to learn how to read, write, use technology, and other useful skills – all of which help increase the efficiency of production.

Why is human capital so important?

Human capital is important because it plays a crucial part in the production process. Examples such as education, training, and experience all contribute to adding value and creating a more efficient process. For instance, a waiter who has had 20 years experience is better equipped to deal with a difficult customer than one who has being in the job for a year. The same can be applied to other industries from manufacturing to the financial sector.

About Paul

Paul Boyce is an economics editor with over 10 years experience in the industry. Currently working as a consultant within the financial services sector, Paul is the CEO and chief editor of BoyceWire. He has written publications for FEE, the Mises Institute, and many others.