Essay on Human Capital | Economic Growth | Economics

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Introduction to Human Capital:

Simon Kuznets (1955) argued that the main stock of an economically advanced country is not its physical capital but “the body of knowledge as tested from findings and discoveries of empirical science, and the capacity and training of its population to use this knowledge effectively.”

The contrast in economic growth between Japan and Germany on one hand and the Third World countries, on the other hand, in the post Second World War (1939-45) period illustrates the importance of labour quality. Although much of the physical capital in Germany and Japan was in ruins or depleted, their economies grew rapidly after the war, as the skill, experience, education, training, health, discipline and motivation of the existing labour force remained intact.

Why is labour productivity higher in developed countries (DCs) such as Japan and Germany than in the LDCs? The key variable is formal education and training. The term ‘human’ refers to the stock of useful and valuable skills and knowledge accumu­lated by people in the process of their education and training. Doctors, lawyers and engineers invest in their formal education and on-the-job training. They spend large sum of money on wages foregone and often work long hours.

A major portion of the high salaries of these profes­sionals should be viewed as a return on their investment in human capital—a return on the education that makes these highly trained workers a very special type of labour.

In other words, human capital refers to the productive capacities of human beings as income producing agents in the economy. Capital is a stock which has value as a source of current and future flow of output and income.

Human capital is the stock of skills and productive knowledge embodied in people. The yield or return on human capital investment lies in enhancing a person’s skills and earning power, and in increasing the efficiency of economic decision-making—both within and without the market economy.

Three Points:

1. Education improves labour productivity by increasing workers’ ability to perform a task quickly and efficiently.

2. Education and human capital formation lead to technological progress.

3. Human capital can act as a substitute of natural capital. So growth of human capital implies a consumption of non-renewable natural resources.

No doubt investment in human capital is productive on average. Individuals who have quan­titative abilities or computer skills have an economic advantage in today’s labour market. Peo­ple with higher education start out with higher incomes and enjoy more rapid growth in income than do less educated groups. The World Development Report (2004) showed that higher PCI is strongly associated with lower mortality and higher school completion.

Often people refer to the role of luck in determining economic circumstances. But chances favour the prepared mind. In a world of rapidly changing technology, education enables a person to understand and profit from new circumstances. [In his permanent income hypothesis, Milton Friedman focussed on the development of a person’s skill and earning capacity over the life cycle and suggested that luck gives temporary income but human capital is a source of permanent income.]

Conservation:

According to environmentalists, output can be produced with either natural capital (K_N) or human capital (K_H). The isoquant in Fig. 1 shows the combination of inputs that will yield a given amount of output in the future (Q*), holding other inputs con­stant. This output can be produced at point C with a very little natural resource (energy) leaving much oil and gas and relatively little human capital for the fu­ture. Alternatively, it might be produced with huge natural resource.

This strategy is feasible if natural capital is abundant. At point B, society consumes stocks of natural capital today and builds up stocks of human capital and improves technology through R and D (i.e., research and development).

Point A indicates that we can produce future output level Q* with no oil and gas. With greater scientific and technical knowl­edge represented by point A, society can develop and introduce substitute technologies like coal or solar energy to replace the exhausted oil and gas.

Contribution of Human Capital to Economic Growth:

In a broad sense, labour inputs consist of workers and of the skills of the workforce. Many economists believe that the quality of labour inputs—the skills, knowledge and discipline of the labour force—is the single most important element in economic growth. A country might buy fast computers, modern telecommunication devices, sophisticated electricity generating equipment, and hypersonic fighter aircraft.

However, these capital goods can be efficiently used and maintained only by skilled and trained workers. Improvements in literacy, health and discipline, and, most recently, the ability to use computers, add greatly to the productivity of labour. India’s green revolution rate had achieved limited success since most farmers were illiterate and did not know how to use modern technology.

Policy Implications:

Perhaps the main policy area where human capital is important is in public provision of train­ing and manpower and development programmes for the poor. The logic of these policies rest on the proposition that a person’s income in a market economy reflects the quality of resources that the person controls and the value of these resources. People who are permanently poor have less skills than the non-poor. So, an attractive policy to help eliminate poverty is to give them more and better resources through education and training.

Signalling and Information:

Spence’s signalling hypothesis maintains that education has no direct effect on improving a per­son’s skills but rather serves as an informational device for identifying more and less talented people. Education serves as a signal of ability.

Since education and ability are highly correlated, higher education implies higher productivity and earnings. Since direct observation of a person’s ability and productivity is costly it is interesting to examine the direct effects of education on productivity (and not on income alone).

Much research has been made on educational production functions. Griliches reviews the issues at the aggregate level. However, the sharpest results have arisen in agriculture, a sector which has shown an enormous and sustained growth in productivity for at least five decades. The rate of return to education among farmers is substantial.

More educated farmers control larger resources in the form of larger farms. These farmers are also much more efficient in their techniques of production. Moreover, their education is used primarily to keep them informed of recent technological changes in agricultural produc­tion, which they adopt with greater frequency and with quicker response. No doubt, education makes farmers more efficient processors of new information.

New Growth Theory:

New growth economists such as Paul Romer stress external economies to capital accumulation that can permanently keep the marginal product of physical or human capital above the interest rate and prevent diminishing returns from causing stagnation.

Views of Schultz and Other Researchers:

In the 1950s, and 1960s economists developed considerable interest in understanding the na­ture and sources of economic growth and development. Detailed national income accounting showed that conventional aggregate output measures grew at a more rapid pace than aggregate measures of factor inputs.

Some researchers identified the-unexplained ‘residual’ with techni­cal change. Research associated with T. W. Schultz and Edward Denison attributed much of the measured residuals to improvements in factor inputs.

Schultz adopted an all-inclusive concept of human capital. At the heart of the concept lay secular improvements in worker’s skills based on education, training and literacy; but he also pointed to sources of progress in improved health and longevity, the reduction in child mortal­ity and greater resources devoted to children in the home, and the capacity of a more educated population to make more intelligent and efficient economic calculations.

No doubt human capital as well as physical capital can yield a stream of income over time: Schultz assumed that a society can invest in its citizens through expenditure, training, re­search and health—that enhances their productive capacity. Although there are direct returns to physical capital by itself, there are constant returns to all (human and physical) capital.

John Kendrick systematically pursued the empirical implications of these ideas and demon­strated that the rate of return on these inclusive human capital investments is of comparable magnitude to yields on non-human capital.

Conclusion:

For all these reasons, developing countries should not underestimate the importance of human resources. Most other factors can be bought in the international market place. Most labour is home-grown, although labour can sometimes be augmented through immigration.

The crucial role of skilled labour has been shown time and again when sophisticated mining, defence or manufacturing machineries fell into disrepair and disuse because the labour force of develop­ing countries had not acquired the necessary skills for its operation and maintenance.

Eco­nomic planners in the developing countries should improve education, reduce illiteracy and train workers. Educated people are more productive because they can use capital more effec­tively, adopt new technologies and learn from their mistakes.

For advanced learning in science, engineering, medicine and management, countries will benefit by sending their best minds abroad to bring back the newest advances. But countries must be aware of the ‘brain drain’ in which the most able people get drawn off to high-wage countries.