What is human capital?
Human capital is an intangible asset or a quality not recorded on the balance sheet of a company. It can be classified as the economic value of a worker’s experience and skills. This includes strengths like education, training, intelligence, skills, health and other things that employers value such as loyalty and punctuality.
The concept of human capital recognizes that all work is not equal. But employers can improve the quality of this capital by investing in employees – the education, experience and skills of employees all have economic value for employers and for the economy as a whole.
Human capital is important because it is perceived to increase productivity and therefore profitability. Thus, the more a company invests in its employees (that is, in their education and training), the more it could be productive and profitable.
Understanding human capital
It is often said that an organization is not as good as its people. The directors, employees and leaders who make up the human capital of an organization are essential to its success.
Human capital is generally managed by the human resources (HR) department of an organization. This department oversees the acquisition, management and optimization of the workforce. Its other directives include workforce planning and strategy, recruitment, employee training and development, and reporting and analysis.
Human capital tends to migrate, especially in global economies. This is why there is often a shift from developing areas or from rural areas to more developed and urban areas. Some economists have called it a brain drain, making the poorest places richer and richer.
Calculation of human capital
Since human capital is based on the investment of employees’ skills and knowledge in education, these investments in human capital can be easily calculated. HR managers can calculate the total profit before and after any investment. Any return on investment (ROI) of human capital can be calculated by dividing the company’s total profits by its total investment in human capital.
For example, if Company X invests $ 2 million in its human capital and makes a total profit of $ 15 million, managers can compare the return on investment of its human capital from year to year (YOY) in order to track how the profit improves and whether it has a relationship with human capital investments.
Key points to remember
- Human capital is an intangible asset that is not on the balance sheet of a business and includes such things as the experience and skills of an employee.
- Since not all work is considered equal, employers can improve human capital by investing in the training, education and benefits of their employees.
- Human capital is seen to be related to economic growth, productivity and profitability.
- Like any other asset, human capital can depreciate due to long periods of unemployment and the inability to keep up with technology and innovation.
Human capital and economic growth
There is a strong relationship between human capital and economic growth. Because people come with a diverse set of skills and knowledge, human capital can certainly help stimulate the economy. This relationship can be measured by the amount of investment spent in educating people.
Some governments recognize that this relationship between human capital and the economy exists and therefore provide higher education at little or no cost. People in the workforce with higher education will often have higher wages, which means they can spend more.
Is human capital depreciating?
Like anything else, human capital is not immune to depreciation. This is often measured in terms of wages or the ability to stay in the labor market. The most common ways of depreciating human capital are unemployment, injuries, mental decline or the inability to keep up with innovation.
Consider an employee who has specialized skill. If they are going through a long period of unemployment, they may not be able to maintain these levels of specialization. Indeed, his skills may no longer be in demand when he finally re-enters the job market.
Likewise, a person’s human capital can depreciate if he cannot or does not want to adopt new technologies or techniques. Conversely, the human capital of those who adopt them will be.
A brief history of human capital
The idea of human capital dates back to the 18th century. Adam Smith referred to the concept in his book “An Inquiry into the Nature and Causes of the Wealth of Nations”, in which he explored the wealth, knowledge, training, talents and experiences of a nation. Adams suggests that improving human capital through training and education leads to a more profitable business, which adds to the collective wealth of society. According to Smith, this makes it a victory for everyone.
More recently, the term has been used to describe the labor required to produce manufactured goods. But the most modern theory has been used by several different economists, including Gary Becker and Theodore Schultz, who coined the term in the 1960s to reflect the value of human capabilities.
Schultz believed that human capital was like any other form of capital to improve the quality and level of production. This would require an investment in education, training and increased benefits for the employees of an organization.
But not all economists agree. According to Harvard economist Richard Freeman, human capital was a signal of talent and ability. In order for a business to become truly productive, he said it had to train and motivate its employees as well as invest in capital goods. He concluded that human capital was not a factor of production.
Criticism of human capital theories
Human capital theory has received much criticism from many people working in education and training. In the 1960s, the theory was attacked mainly because it legitimized bourgeois individualism, considered to be selfish and exploitative. The bourgeois class included those of the middle class who were supposed to exploit those of the working class.
It was also believed that the theory of human capital would blame people for all the faults that have occurred in the system and for making capitalists workers.