Sources Of Human Capital

Investment in education is considered as one of the main sources of human capital. There are several other sources as well. Investments in health, on-the-job training, migration and information are the other sources of human capital formation.

Why do your parents spend money on education? Spending on education by individuals is similar to spending on capital goods by companies with the objective of increasing future profits over a period of time. Likewise, individuals invest in education with the objective of increasing their future income.

Like education, health is also considered as an important input for the development of a nation as much as it is important for the development of an individual.

Who can work better — a sick person or a person with sound health? A sick labourer without access to medical facilities is compelled to abstain from work and there is loss of productivity. Hence, expenditure on health is an important source of human capital formation.

Preventive medicine (vaccination), curative medicine (medical intervention during illness), social medicine (spread of health literacy) and provision of clean drinking water and good sanitation are the various forms of health expenditures. Health expenditure directly increases the supply of healthy labour force and is, thus, a source of human capital formation.

Firms spend on giving on-the-job training to their workers. This may take different forms –

  • one, the workers may be trained in the firm itself under the supervision of a skilled worker;
  • two, the workers may be sent for off-campus training.

In both these cases firms incur some expenses. Firms will, thus, insist that the workers should work for a specific period of time, after their on-the-job training, during which it can recover the benefits of the enhanced productivity owing to the training. Expenditure regarding on-the-job training is a source of human capital formation as the return of such expenditure in the form of enhanced labour productivity is more than the cost of it.

People migrate in search of jobs that fetch them higher salaries than what they may get in their native places. Unemployment is the reason for the rural-urban migration in India. Technically qualified persons, like engineers and doctors, migrate to other countries because of higher salaries that they may get in such countries. Migration in both these cases involves cost of transport, higher cost of living in the migrated places and psychic costs of living in a strange sociocultural setup. The enhanced earnings in the new place outweigh the costs of migration; hence, expenditure on migration is also a source of human capital formation.

People spend to acquire information relating to the labour market and other markets like education and health. For example, people want to know the level of salaries associated with various types of jobs, whether the educational institutions provide the right type of employment skills and at what cost. This information is necessary to make decisions regarding investments in human capital as well as for efficient utilisation of the acquired human capital stock. Expenditure incurred for acquiring information relating to the labour market and other markets is also a source of human capital formation.

The concept of physical capital is the base for conceptualizing human capital. There are some similarities between the two forms of capital; there are some striking dissimilarities as well.

Physical And Human Capital

Both the forms of capital formation are outcomes of conscious investment decisions. Decision regarding investment in physical capital is taken on the basis of one’s knowledge in this regard. The entrepreneur possesses knowledge to calculate the expected rates of return to a range of investments and than rationally decides which one of the investments should be made. The ownership of physical capital is the outcome of the conscious decision of the owner — the physical capital formation is mainly an economic and technical process. A substantial part of the human capital formation takes place in one’s life when she/he is unable to decide whether it would maximise her/his earnings. Children are given different types of school education and health care facilities by their parents and the society. The peers, educators and society influence the decisions regarding human capital investments even at the tertiary level, that is, at the college level. Moreover, the human capital formation at this stage is dependent upon the already formed human capital at the school level. Human capital formation is partly a social process and partly a conscious decision of the possessor of the human capital.

The owner of a physical capital, says a bus, need not be present in the place where it is used; whereas, a bus-driver, who possesses the knowledge and ability to drive the bus, should be present when the bus is used for transportation of men and materials. Physical capital is tangible and can be easily sold in the market like any other commodity. Human capital is intangible; it is endogenous, built-in the body and mind of its owner. Human capital is not sold in the market; only the services of human capital are sold and hence the necessity of the owner of the human capital to be present in the place of production. The physical capital is separable from its owner, whereas, human capital is inseparable from its owner.

The two forms of capital differ in terms of mobility across space –

  • Physical capital is completely mobile between countries except for some artificial trade restrictions.
  • Human capital is not perfectly mobile between countries as movement is restricted by nationality and culture.

Therefore, physical capital formation can be built even through imports, whereas human capital formation is to be done through conscious policy formulations in consonance with the nature of the society and economy and expenditure by the state and the individuals.

Both forms of capital depreciate with time but the nature of depreciation differs between the two. Continuous use of machine leads to depreciation and change of technology makes a machine obsolete. In the case of human capital, depreciation takes place with ageing but can be reduced, to a large extent, through continuous investment in education, health, etc. This investment also facilitates the human capital to cope with change in technology which is not the case with physical capital.

Nature of benefits flowing from human capital are different from that of physical capital. Human capital benefits not only the owner but also the society in general. This is called external benefit. An educated person can effectively take part in a democratic process and contribute to the socio-economic progress of a nation. A healthy person, by maintaining personal hygiene and sanitation, stops the spread of contagious diseases and epidemics. Human capital creates both private and social benefits, whereas physical capital creates only private benefit. That is, benefits from a capital good flow to those who pay the price for the product and services produced by it.


Human Capital And Economic Growth

Who contributes more to national income — a worker in a factory or a software professional? We know that the labour skill of an educated person is more than that of an uneducated person and that the former generates more income than the latter. Economic growth means the increase in real national income of a country; naturally, the contribution of the educated person to economic growth is more than that of an illiterate person. If a healthy person could provide uninterrupted labour supply for a longer period of time, than health is also an important factor for economic growth. Thus, both education and health, along with many other factors like on-the-job training, job market information and migration, increase an individual’s income generating capacity.

This enhanced productivity of human beings or human capital contributes substantially not only towards increasing labour productivity but also stimulates innovations and creates ability to absorb new technologies. Education provides knowledge to understand changes in society and scientific advancements, thus, facilitate inventions and innovations. Similarly, the availability of educated labour force facilitates adaptation to new technologies.

Empirical evidence to prove that increase in human capital causes economic growth is rather nebulous. This may be because of measurement problems. For example, education measured in terms of years of schooling, teacher-pupil ratio and enrolment rates may not reflect the quality of education; health services measured in monetary terms, life expectancy and mortality rates may not reflect the true health status of the people in a country. Using the indicators mentioned above, an analysis of improvement in education and health sectors and growth in real per capita income in both developing and developed countries shows that there is convergence in the measures of human capital but no sign of convergence of per capita real income. In other words, the human capital growth in developing countries has been faster but the growth of per capita real income has not been that fast. There are reasons to believe that the causality between human capital and economic growth flows in either directions. That is, higher income causes building of high level of human capital and vice versa, that is, high level of human capital causes growth of income.

India recognised the importance of human capital in economic growth long ago. The Seventh Five Year Plan says, “Human resources development (read human capital) has necessarily to be assigned a key role in any development strategy, particularly in a country with a large population. Trained and educated on sound lines, a large population can itself become an asset in accelerating economic growth and in ensuring social change in desired directions.”

It is difficult to establish a relation of cause and effect from the growth of human capital (education and health) to economic growth but we can see in below table that these sectors have grown simultaneously. Growth in each sector probably has reinforced the growth of every other sector.


Two independent reports on the Indian economy, in recent times, have identified that India would grow faster due to its strength in human capital formation. Deutsche Bank, a German bank, in its report on ‘Global Growth Centres’ (published on 1.7.05) identified that India will emerge as one among four major growth centres in the world by the year 2020. It further states, “Our empirical investigation supports the view that human capital is the most important factor of production in today’s economies. Increases in human capital are crucial to achieving increases in GDP.” With reference to India it states, “Between 2005 and 2020 we expect a 40 per cent rise in the average years of education in India, to just above 7 years…”

World Bank, in its recent report, ‘India and the Knowledge Economy —Leveraging Strengths and Opportunities’, states that India should make a transition to the knowledge economy and if it uses its knowledge as much as Ireland does (it is judged that Ireland uses its knowledge economy very effectively), then the per capita income of India will increase from a little over US $1000 in 2002 to US $ 3000 in 2020. It further states that the Indian economy has all the key ingredients for making this transition, such as, a critical mass of skilled workers, a well-functioning democracy and a diversified science and technology infrastructure. Thus the two reports point out the fact that further human capital formation in India will move its economy to a higher growth trajectory.

India As A Knowledge Economy

The Indian software industry has been showing an impressive record over the past decade. Entrepreneurs, bureaucrats and politicians are now advancing views about how India can transform itself into a knowledge-based economy by using information technology (IT). There have been some instances of villagers using e-mail which are cited as examples of such transformation. Likewise, e-governance is being projected as the way of the future. The value of IT depends greatly on the existing level of economic development. IT can make existing assets and processes more effective and efficient but, first of all, a basic infrastructure needs to be developed.


Bibliography : NCERT – Indian Economic Development



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