human capital, intangible collective resources possessed by individuals and groups within a given population. These resources include all the knowledge, talents, skills, abilities, experience, intelligence, training, judgment, and wisdom possessed individually and collectively, the cumulative total of which represents a form of wealth available to nations and organizations to accomplish their goals.
Will Kenton is an expert on the economy and investing laws and regulations. He previously held senior editorial roles at Investopedia and Kapitall Wire and holds a MA in Economics from The New School for Social Research and Doctor of Philosophy in English literature from NYU.
The term human capital refers to the economic value of a worker’s experience and skills. Human capital includes assets like education, training, intelligence, skills, health, and other things employers value such as loyalty and punctuality. As such, it is an intangible asset or quality that isn’t (and can’t be) listed on a company’s balance sheet. Human capital is perceived to increase productivity and thus profitability. The more investment a company makes in its employees, the chances of its productivity and success become higher.
Understanding Human Capital
An organization is often said to only be as good as its people from the top down, which is why human capital is so important to a company. It is typically managed by an organization’s human resources (HR) department, which oversees workforce acquisition, management, and optimization. Its other directives include workforce planning and strategy, recruitment, employee training and development, and reporting and analytics.
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. This can be done through the education, experience, and abilities of employees. All of this has great economic value for employers and for the economy as a whole.
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 5000 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.
Managing human capital
The management of human capital is diffused throughout an organization. All management decisions and actions that affect the nature of the relationship between the organization and its employees are seen as important. As a result, all management actions can positively or negatively affect the potential of human capital to influence organization performance. In this view, although the organization may contribute to the development of human capital, its ownership rests with each individual. Collectively, all the knowledge, skills, and abilities within an organization and available at any given time constitute a human capital pool. Although this talent is available to achieve positive performance, the totality of management practices needs to consistently tap this human capital pool in such ways as to influence individual and group attitudes and behaviour toward the desired organizational goals.
Reciprocal commitment in an organization suggests that a relationship exists between certain management practices and performance. At a point where the total effort of human capital coalesces into a critical mass, high organizational performance seems possible. Here, human capital, fully developed and tapped appropriately, can influence organization-level outcomes. Empirical research in the private sector appears to identify specific management practices as universally superior to others in achieving firm-level outcomes such as market share and profitability. This universal perspective has led to benchmarking certain practices as “best” for contributing to high performance. Empirical research in the public sector establishing such a relationship is sparse. This may be the result of difficulties in measuring government-level outcomes and being able to clearly establish this connection, because outcomes are often influenced by a myriad of variables outside the control of public management. Even so, the same superior management practices thought to favourably influence human capital in private enterprise have been often adopted in public administration reforms.
Practices thought to result in a high-quality, committed, and flexible workforce in private enterprise are also seen as important contributors to productivity and performance in the public sector. High levels of expenditures in training and development, empowering workers with decentralized decision-making authority, and encouraging participation, pay for performance, the use of self-managed work teams, and flexible job designs, among others, are commonly associated with improved performance in public agencies. Theories of motivation support such management practices where the first priority is to ensure that workers have the skills and ability to perform (training and development) and where the second priority is to afford them the opportunity to test their problem-solving skills (decentralized decision authority). The belief is that investing heavily in improving worker skills and abilities leads to a higher-quality workforce. This combined with valued rewards and a role in problem solving can result in greater effort, commitment, and motivation within a workforce that is more flexible and innovative. This combination then, it is thought, results in higher organization performance.
Human capital is available to generate material wealth for an economy or a private firm. In a public organization, human capital is available as a resource to provide for the public welfare. How human capital is developed and managed may be one of the most important determinants of economic and organizational performance.
What Is Human Capital Management & Why Is It Important?
Renovations to a building will generally increase the building’s value, and inventory that sits on a shelf for months will generally decrease in value. But how do you impact the value of an intangible asset like an employee?
The second, however, is that for many companies the cost of their workforce is often their greatest expense. As a result, HCM has become the driving force behind many new business practices, a growing abundance of human capital management software solutions, and an emphasis on the concept of human capital as a competitive advantage.
Maybe you’re an HR professional and want to educate yourself or your colleagues, or perhaps you’re the leader, owner, or founder of a startup or small business, or you’re wondering if HR is the career path for you. Either way, this will equip you with the basic fundamentals of HCM and enable you to get started on practicing it in your own organization.
What is Human Capital Management (HCM)?
While referring to human beings and employees as “capital” might seem harsh—and some joke about the similarity between the words “capital” and “cattle”—it can actually help an organization shift it’s perspective and view employees as an asset that can increase in value. Organizations that do this focus on activities such as learning and development initiatives, health and well-being programs, and specialized skills development, which brings rewards to both the individual employee and the organization.
So what is human capital management?
Human capital management, or “HCM” for short, is the collection of organizational practices related to the acquisition, management, and development of the human workforce—or human capital—within an organization.
The goal of HCM is to optimize and maximize the economic, or business, value of an organization’s human capital in order to gain a competitive advantage. Effective human capital management enables the organization to successfully pursue human capital initiatives.
Importance of human capital
- Structural unemployment. Individuals whose human capital is inappropriate for modern employers may struggle to gain employment. A major issue in modern economies is that rapid deindustrialisation has left many manual workers, struggling to thrive in a very different labour market.
- Qualityof employment. In the modern economy, there is increasing divergence between low-skilled, low-paid temporary jobs (gig economy). High-skilled and creative workers have increased opportunities for self-employment or good employment contracts.
- Economic growth and productivity. Long-term economic growth depends increasingly on improvements in human capital. Better educated, innovative and creative workforce can help increase labour productivity and economic growth.
- Human capital flight. An era of globalisation and greater movement of workers has enabled skilled workers to move from low-income countries to higher income countries. This can have adverse effects for developing economies who lose their best human capital.
- Limited raw materials. Economic growth in countries with limited natural resources, e.g. Japan, Taiwan and South East Asia. Rely on high-skilled, innovative workforce adding value to raw materials in the manufacturing process.
- Sustainability ”what we leave to future generations; whether we leave enough resources, of all kinds, to provide them with the opportunities at least as large as the ones we have had ourselves” (UN, 2012)
Different views on Human Capital
“Although it is obvious that people acquire useful skills and knowledge, it is not obvious that these skills and knowledge are a form of capital, that this capital is in substantial part a product of deliberate investment”
Gary Becker “Human Capital” (1964) In his view, human capital, is determined by education, training, medical treatment, and is effectively a means of production. Increased human capital explains the differential of income for graduates. Human capital is also important for influencing rates of economic growth.
Howard Gardener – different types of human capital. Gardener emphasised the different types of human capital. One could increase education, but be a poor manager. A successful entrepreneur may have no education. Human capital is not unidimensional.
Schultz/Nelson-Phelps – ability to adapt. Human capital should be looked at from the ability to adapt. Can workers adapt to a changing labour market? A labour market which is shifting from full-time manual work in manufacturing to flexible work in the service sector.
Evaluation of human capital
Social upbringing. A sociologist like Pierre Bourdieu argues that human capital is strongly related to social upbringing. This influences cultural, social and symbolic forms of capital. For example, UK society dominated by Old Etonians and Oxbridge graduates who gain confidence and social capital from having the right social networks.
Signalling. Related to the social capital of going to the right school, is the idea that what constitutes human capital is often just ‘signalling’. For example, gaining a degree from Oxbridge improves status in the workforce and enables a higher salary for the graduate. However, three years of studying a degree in modern history/PPE may give only a small amount of knowledge directly related to the work environment.
Discrimination. Differences in wages and job opportunities are not necessarily due to differences in human capital, but the result of discrimination, labour market imperfections or non-monetary benefits of jobs.
32 thoughts on “Human Capital definition and importance”
I don’t believe in capitalism, Capatital is just a term for money, money belongs to no one but the federal union, lets say you got paid and the money came from your parents, even if it did, your parents didn’t just get the money from no where.
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The term HCM can refer both to a business strategy and a set of modern IT applications and other technologies that are used to implement that strategy. Though sometimes used interchangeably, the terms related HR, HRMS, and HRIS do have subtle distinctions:
Human Capital Theory
Human capital theory, initially formulated by Becker (1962) and Rosen (1976), argues that individual workers have a set of skills or abilities which they can improve or accumulate through training and education.
4 Human Capital
Human capital theory is concerned with knowledge and experiences of small-scale business owners. The general assumption is that the human capital of the founder improves small firms’ chances of survival (Bruederl et al. 1992 ). Human capital acts as a resource. However, human capital theory studies usually assume that experiences are translated into knowledge and skills. This assumption is problematic, however, because length of experience is not necessarily a good predictor of expertise (Sonnentag 1995 ). Therefore, it is not surprising that human capital factors, such as length of managerial or industry experiences or education, are not strong predictors of success, although in large-scale studies they usually are significant (Bruederl et al. 1992 , Rauch and Frese 2000 ).
Empirical Estimates and Methodology
Although human capital theory suggests that individuals invest in education in anticipation of a wide range of benefits, most empirical work has focused on the monetary rewards of increased earnings. Such data have tended to show rates of return of about 10% for an additional year of education, with some variation by gender and race/ethnicity ( Psacharopoulos and Patrinos 2004 ). These return measures ignore nonmonetary and consumption benefits of education, and they also ignore any externalities associated with education. There has been substantial work done on these latter topics which are discussed later in this article.
Several methodological issues arise in estimating the returns to education. The goal of most empirical work is to establish a causal link between education and measures of return, which tends to be much more difficult than simply measuring a correlation. Early work compared lifetime earnings profiles for groups with different levels of educational attainment. More advanced analysis based on multiple regression analysis has attempted to account for a host of technical estimation problems such as omitted variables, nonrandom samples, incorrectly measured variables, and jointly determined outcomes. These issues are discussed briefly in what follows.
A key omitted variable in much empirical work is innate ability (e.g., natural intelligence, work ethic) which can also include unobserved effort. The fundamental difficulty is that high-ability individuals are likely to obtain more years of schooling than low-ability individuals, but high-ability individuals would also tend to earn more for any given amount of schooling than low-ability individuals. This makes it difficult to disentangle the effect of schooling versus innate ability.
A large literature is devoted to investigating and overcoming this particular problem. Ideally, a researcher would like to observe otherwise identical individuals who differ only in their level of education. Although this approach is impossible in practice, clever research strategies using advanced econometrics have been employed with varying degrees of success.
Nonrandom sampling is often a problem with estimating returns to education for individuals with weak attachment to the labor market. For example, in contrast to most college-educated males, a substantial fraction of women who graduate from college will exit the workforce for extended periods of time. This implies that estimating returns to college will rely on a subset of the available data (women who work) that might not be representative of the full population of women. As with accounting for unobserved ability, a large literature has developed to account for this type of problem, again, with varying degrees of success.
Measurement error can afflict several variables of interest in empirical models. One example is earnings: earnings can be misstated in surveys because of carelessness by either the responder or the person (or machine) coding the information; or, responder wariness toward the survey instrument might lead to inaccurate data. Another example is in the measurement of school quality: a year of schooling from an Ivy League college might be very different than a year of schooling from the local junior college. Such problems cloud the measurement of the causal relationship between schooling and earnings, and the relationship between human capital accumulation and outcomes more generally. Several approaches have been used to account for this problem, the simplest of which is the development of better data sources.
The problem of jointly determined variables, also known as endogeneity, arises in situations where multiple outcomes are simultaneously decided upon. For example, household fertility decisions are likely to be made jointly with decisions about the level and type of education to obtain. This makes it difficult to measure a causal impact of one endogenous variable on another, although such causal links are theoretically possible. For example, it seems likely that having additional children makes it more costly and therefore less probable that a person will pursue additional years of education. But measuring the independent effect is confounded by the joint-decision process. The typical strategy to deal with endogeneity is to use an econometric technique known as instrumental variables estimation. Alternative complex estimation techniques have also been used in the empirical literature.
Human Capital Theory
Human Capital theory originates from Adam Smith in 1776, with his book ‘The Wealth of Nations’. Gary Becker later went on to build upon Smith’s original theory who went on to coin the term ‘Human Capital’ in his 1964 book.
Becker highlighted a key similarity between what we normally consider as capital and ‘human capital’. He highlighted that traditional ‘capital’ such as stocks, steel plants, or assembly lines produce a yield – they are an investment that produces further income.
Becker went on to state that this could also be applied to ‘human capital’ such as schooling or on-the-job training. Both increase the economic output of the individual, so act in a similar way as a new steel plant. So the more education an individual has, the more they are capable of producing an earning, thereby increasing their worth to the firm.
Human Capital Theory also considers other factors such as medical care, migration, and information on prices, as human capital. The reasoning for such is that goods such as healthcare can prolong life or reduce the length of sickness.
Either way, it allows the recipient more time to work. For instance, an illness that may last a week could be reduced to only one day through anti-biotics. That’s four additional workdays gained, thereby increasing the economic output achieved.
Human Capital Examples
We can think of ability in two ways: natural and developed. Natural ability refers to the abilities we have when we are born. For instance, Lionel Messi is known for his extraordinary ability in soccer. This was noticeable at a very young age and can be considered as human capital.
Though this natural ability, he has been able to make millions. Yet at the same time, this ability also needs hard work, good attitude, and nourishing. This is how the natural ability translates into a developed ability and in turn an economic advantage.
It can be argued that creativity is not necessarily something that can be developed. In fact, it could be considered a natural ability. Some are more naturally creative than others. In turn, this can make some more productive in creative roles than others.
This is the area which Human Capital Theory focuses on most greatly. As the wider population has learnt to read and write, the ability to learn and transfer knowledge has increased. For instance, the ability to read and write allows us to go through the internet and learn new skills.
However, education extends beyond reading and writing. It also includes the development of our analytical abilities. History for example requires writing techniques, whilst Science requires the development of research and investigation.
The logic is that the more experiences we have, the more situations we face. So an electrician is far more capable if he has experience dealing with different types of units. When they are called out, they can recall their experiences to deal with a situation.
As part of human capital, judgment refers to the decision people make in different situations. In part, this can be seen as natural. Yet judgment can be built upon and developed. For instance, making a judgment call on a yearly project could be improved if the employee has experienced the situation before.