What is Human Capital

Human capital is a quantification of the economic value of a worker's skill set. This measure builds on the basic production input of labor measure where all labor is thought to be equal. The concept of human capital recognizes that not all labor is equal and that the quality of employees can be improved by investing in them; the education, experience and abilities of employees have economic value for employers and for the economy as a whole.

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Human Capital

BREAKING DOWN Human Capital

Economist Theodore Schultz invented the term "human capital" in the 1960s to reflect the value of human capacities. He believed human capital was like any other type of capital; it could be invested in through education, training and enhanced benefits that lead to an improvement in the quality and level of production.

An organization is often said to only be as good as its people. Directors, employees and leaders that make up an organization's human capital are critical to its success. Human capital is typically managed by an organization's human capital management (HCM) department, commonly referred to as the human resources (HR) department. A HCM department oversees the organization's workforce acquisition, management and optimization. The HCM department's other directives include workforce planning and strategy, recruitment, employee training and development, and reporting and analytics.

Human capital tends to migrate, especially in global economies. That is why you will see a shift of this type of capital from developing places or rural areas to more developed and urban areas. Some economists have dubbed this a "brain drain" — making poorer places poorer and richer places richer. 

Techniques to Keep Employees Content

To ensure employees are effective contributors to the organization, it is critical they remain content and are made to feel part of the company's culture using effective human capital strategies. Employers need to remain transparent. Employees value the truth in regards to an organization's overall financial performance and operations. Work-life balance rates highly with employees. It is important for employers to foster a culture where the employees feel that their lives outside of the company are respected and valued. An organization that values open communication should consider establishing common areas where employees can congregate and share ideas. Employers need to have a clear career pathway in place for employees who are focused on career advancement. Employees are motivated by feeling recognized by the organization and their peers. This can be as simple as issuing an employee with an achievement award.

Human Capital Management Outperforms

Ultimately, an organization's goal is to generate a profit. Companies that utilize human capital initiatives outperform their peers. Research from business management consulting firm McKinsey & Company indicates that ethnically diverse organizations outperform their peers by 35%, and gender-diverse organizations outperform their peers by 15%. Other studies have concluded that organizations with more female board members outperform those organizations that don’t.

Calculating Human Capital

Since human capital is based on investing in the skills and knowledge of employees through education, these investments in human capital can be easily calculated. The managers who oversee human capital (i.e., the HR department) can calculate the total profits before and after any investments are made. Any return on investment (ROI) of human capital can be calculated by dividing the company’s total profits by its overall investments in human capital. For example, if Company X invests $2 million into its human capital and has a total profit of $15 million, managers can compare the ROI of its human capital year-over-year (YOY) in order to track how profit is improving and whether it has a relationship to the human capital investments. 

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 give a boost to the economy. This relationship can be measured by how much investment goes into people’s education. Some governments recognize that this relationship between human capital and the economy exists, and therefore provide higher education at little or no cost. People who participate in the workforce who have a higher education will often have larger salaries, which means they will be able to spend more. 

Does Human Capital Depreciate?

Like anything else, human capital is not immune to depreciation, which is often measured in wages or the ability to stay in the workforce. In this case, the most common ways that human capital can depreciate are unemployment, injury, mental decline or the inability to keep up with innovation. Because many employees have specialized skills that they bring into the workforce, long periods of unemployment may make then unable to keep these levels of specialization, because their skills may no longer be in demand when they are finally able to enter the workforce. Furthermore, the human capital of an employee who is unable or unwilling to adopt new technology or techniques may decrease or depreciate when compared to his more willing competitors.

Criticism of Human Capital Theories

The theory of human capital has received a lot of criticism from many people who work in education and training. In the 1960s, the theory was attacked primarily because it legitimized bourgeois individualism, which was seen as selfish and exploitative. The bourgeois class of people, as labeled by Marx, were those of the middle class who were believed to exploit those of the working class (or the proletariat). The human capital theory was also believed to blame people for any defects that happened in the system and of making capitalists out of workers.