Human Capital 571
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The concept of human capital refers to the education, on-the job training, and work experience of the labor force. It is analogous to other forms of capital in that investments in human capital yield income and other benefits over a long time. An investment in human capital means investing in education or some form of on-the job training to improve workforce quality. Such investments provide returns to the individual as well as to the economy as a whole. Individuals benefit from higher earnings, and the economy as a whole benefits from higher productivity.

Human capital theory is concerned with finding ways to measure human capital and the rate of return on investments in human capital, both to the individual and to the economy as a whole. The quality of the labor force, or investment in human capital, can be measured in different ways. One way is to measure expenditures on education and training. Since the overall health of workers also affects productivity, investments in medical care are sometimes considered human capital expenditures.

A 1998 survey of 12 developed nations indicated that investment in human capital accounted for at least 10 percent of national income in most countries. This included public and private expenditures on initial education as well as spending on training after school. Policy issues related to such a level of expenditure include what volume of spending would be appropriate, how resources should be allocated among different types of human capital investments, and what part of the cost should be borne by companies, individuals, and government agencies.

Public policy decisions regarding investment in human capital rely on measuring the rates of return on such investments. Restrictive measurements compare the additional earnings from employment of better educated or -trained individuals to the additional social cost of investing in more education. Other less restrictive measurements take into account the social and economic benefits of such investments, such as better public health, lower crime, and a better environment.

Another method of measuring the quality of a country's labor force is to determine its occupational composition. In the United States, for example, the percentage of laborers and unskilled workers has decreased over time, while the percentage of professionals, managers, executives, and technical workers has increased. These changes during the 20th century indicate that the quality of the labor force has risen. Such a change can be quantified to determine how rapidly the average skill level of the labor force has risen over time.

Studies have shown that investments in human capital are essential for sustaining economic growth over time. The law of diminishing returns suggests that investments in physical capital and land eventually fail to result in economic growth. Yet, countries such as the United States, Japan, and many European nations have sustained economic growth over the past century. Heavy investment in the training of workers and a better educated labor force are given credit for much of the growth in per capita incomes and economic productivity. A comparison of modern, educated farmers with farmers in traditional economies shows the need for educating workers to help them cope with changing technologies.

While economists have been able to demonstrate a statistical relationship between education and earnings, they have not been able to conclusively show a cause-and-effect relationship. That is, while higher earnings are associated with more education, it has yet to be conclusively shown that more education leads to higher earnings. The theory that more education is a causative factor in higher earnings has been attacked on two points. One is the ability problem, or the fact that more-highly educated individuals are also likely to have the ability, self-discipline, and motivation that also result in higher earnings. Such individuals tend to do well in the labor market, it is argued, not because of their education, but because of other abilities.

A second critique of the human capital theory is the screening hypothesis, which states that higher levels of education serve to grade and label individuals in the job market. That is, higher levels of education do not necessarily make individuals more productive, they simply give people credentials that are then associated with higher-paying jobs. If this criticism is valid, then it can be argued that greater social expenditures on education may not result in as much increased economic productivity as the human capital model would suggest.

The concept of human capital can be applied to the individual firm as well as to the economy as a whole. The expertise of a company's employees is often referred to as its intellectual capital. It may include such intellectual assets as patents, processes, management skills, technologies, information systems, and customer knowledge. Like human capital, intellectual capital is difficult to measure, and companies that recognize its benefits are seeking ways to manage and codify it.

With access to capital and technology tending to level the playing field between companies, human capital has become essential to sustaining a competitive advantage. In order to gain the most from investments in human capital, and in recognition of the importance of people processes, companies are linking individual behavior with corporate goals. The strategic approach to human capital focuses on processes such as dialogue and discussion. Strategies to develop human capital within an organization also focus on the future and take a long-term approach.

Companies can invest in intellectual capital, just as countries invest in human capital, through training programs and hiring practices. Human resources departments can develop a long-term strategy to maximize human capital. Social investment in human capital is a matter of public policy. Examples of policies that tend to increase a country's stock of human capital include using the human capital of women, investing in higher education, supporting dropout prevention programs, and encouraging highly skilled immigrants to enter the workforce.

SEE ALSO : Human Resource Management

[ David P. Bianco ]


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OECD Staff. Human Capital Investment: An International Comparison. Washington: Organization for Economic Cooperation and Development, 1998.

Sorkin, Alan S., ed. Research in Human Capital and Development, vol. I1. Stanford, CA: Jai Press, 1997.

Stewart, Thomas A. Intellectual Capital: The New Wealth of Organizations. New York: Doubleday, 1997.

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