What Is Human Capital?

Human capital is an intangible asset or quality not listed on a company's balance sheet. It can be classified as the economic value of a worker's experience and skills. This includes assets like education, training, intelligence, skills, health, and other things employers value such as loyalty and punctuality.

The concept of human capital recognizes that not all labor is equal. But employers can improve the quality of that capital by investing in employees—the education, experience, and abilities 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. So the more a company invests in its employees (i.e. in their education and training), the more productive and profitable it could be.

Understanding Human Capital

An organization is often said to only be as good as its people. Directors, employees, and leaders who make up an organization's human capital are critical to its success.

Human capital is typically managed by an organization's human resources (HR) department. This department oversees workforce acquisition, management, and optimization. Its 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's why there is often a shift 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. 

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Human Capital

Calculating Human Capital

Since human capital is based on the investment of employee skills and knowledge through education, these investments in human capital can be easily calculated. HR managers 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. 

Key Takeaways

  • Human capital is an intangible asset not listed on a company's balance sheet and includes things like an employee's experience and skills.
  • Since all labor is not considered equal, employers can improve human capital by investing in the training, education, and benefits of their employees.
  • Human capital is perceived to have a relationship with economic growth, productivity, and profitability.
  • Like any other asset, human capital can depreciate through 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 boost 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 provide higher education at little or no cost. People who participate in the workforce who have 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. This is often measured in wages or the ability to stay in the workforce. The most common ways human capital can depreciate are through unemployment, injury, mental decline or the inability to keep up with innovation.

Take an employee who has a specialized skill. If he goes through a long period of unemployment, he may be unable to keep these levels of specialization. That's because his skills may no longer be in demand when he finally reenters the workforce.

Similarly, the human capital of someone may depreciate if he can't or won't adopt new technology or techniques. Conversely, the human capital of someone who does adopt them will.

History of Human Capital

The idea of human capital can be traced 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, where he explored the wealth, knowledge, training, talents, and experiences for a nation. In it, he suggests improving human capital through training and education leads to a more profitable enterprise which, therefore, adds to the collective wealth of society. Basically, Smith contends it's a win-win for everyone.

In more recent times, the term was used to describe the labor required to produce manufactured goods. But the most modern theory was used by several different economists including Gary Becker and Theodore Schultz—who invented the term in the 1960s to reflect the value of human capacities.

Schultz believed human capital was like any other form of capital to improve the quality and level of production. This would require an investment in the education, training and enhanced benefits of an organization's employees.

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 really become productive, he said it needed to train and motivate its employees as well as invest in capital equipment. His conclusion was that human capital was not a production factor.

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 were those of the middle class who were believed to exploit those of the working class. 

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.