What Is Human Capital?
Think of one factor that has made a great difference in the evolution of mankind. Perhaps it is man’s capacity to store and transmit knowledge which he has been doing through conversation, through songs and through elaborate lectures.
Man soon found out that we need a good deal of training and skill to do things efficiently.
The labour skill of an educated person is more than that of an uneducated person and hence the former is able to generate more income than the latter and his contribution to economic growth is, consequently, more.
Education is sought not only as it confers higher earning capacity on people but also for its other highly valued benefits –
- it gives one a better social standing and pride;
- it enables one to make better choices in life;
- it provides knowledge to understand the changes taking place in society;
- it also stimulates innovations.
Moreover, the availability of educated labour force facilitates adaptation of new technologies. Economists have stressed the need for expanding educational opportunities in a nation as it accelerates the development process.
Just as a country can turn physical resources like land into physical capital like factories, similarly, it can also turn human resources like students into human capital like engineers and doctors. Societies need sufficient human capital in the first place — in the form of competent people who have themselves been educated and trained as professors and other professionals. In other words, we need good human capital to produce other human capital (say, doctors, engineers…). This means that we need investment in human capital to produce more human capital out of human resources.
Let us understand a little more of what human capital means by posing the following questions –
- (i) What are the sources of human capital?
- (ii) Is there any relation between human capital and economic growth of a country?
- (iii) Is the formation of human capital linked to man’s all-round development or, as it is now called, human development?
- (iv) What role can the government play in human capital formation in India?
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 –
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.
Human Capital And Human Development
The two terms sound similar but there is a clear distinction between them –
- Human capital considers education and health as a means to increase labour productivity.
- Human development is based on the idea that education and health are integral to human well-being because only when people have the ability to read and write and the ability to lead a long and healthy life, they will be able to make other choices which they value.
Human capital treats human beings as a means to an end; the end being the increase in productivity. In this view, any investment in education and health is unproductive if it does not enhance output of goods and services.
In the human development perspective, human beings are ends in themselves. Human welfare should be increased through investments in education and health even if such investments do not result in higher labour productivity. Therefore, basic education and basic health are important in themselves, irrespective of their contribution to labour productivity. In such a view, every individual has a right to get basic education and basic health care, that is, every individual has a right to be literate and lead a healthy life.
Human Capital Formation In India : Great Prospects
Human capital formation is the outcome of investments in education, health, on-the-job training, migration and information : of these education and health are very important sources of human capital formation.
Ours is a federal country with a union government, state governments and local governments (Municipal Corporations, Municipalities and Village Panchayats). The Constitution of India mentions the functions to be carried out by each level of government. Accordingly, expenditures on both education and health are to be carried out simultaneously by all the three tiers of the government.
Who takes care of education and health in India? Education and health care services create both private and social benefits and this is the reason for the existence of both private and public institutions in the education and health service markets.
Expenditures on education and health make substantial long-term impact and they cannot be easily reversed; hence, government intervention is essential.
- For instance, once a child is admitted to a school or health care centre where the required services are not provided, before the decision is taken to shift the child to another institution, substantial amount of damage would have been done. Moreover, individual consumers of these services do not have complete information about the quality of services and their costs. In this situation, the providers of education and health services acquire monopoly power and are involved in exploitation. The role of government in this situation is to ensure that the private providers of these services adhere to the standards stipulated by the government and charge the correct price.
In India, the ministries of education at the union and state level, departments of education and various organisations like National Council of Educational Research and Training (NCERT), University Grants Commission (UGC) and All India Council of Technical Education (AICTE) regulate the education sector.
Similarly, the ministries of health at the union and state level, departments of health and various organisations like Indian Council for Medical Research (ICMR) regulate the health sector.
In a developing country like ours, with a large section of the population living below the poverty line, many of us cannot afford to access basic education and health care facilities. Moreover, a substantial section of our people cannot afford to reach super speciality health care and higher education. Furthermore, when basic education and health care is considered as a right of the citizens, then it is essential that the government should provide education and health services free of cost for the deserving citizens and those from the socially oppressed classes.
Both, the union and state governments, have been stepping up expenditures in the education sector over the years in order to fulfil the objective of attaining cent per cent literacy and considerably increase the average educational attainment of Indians.
Education Sector In India
Growth In Government Expenditure On Education
How much do the government spends on education? This expenditure by the government is expressed in two ways –
- (i) as a percentage of ‘total government expenditure’
- The percentage of ‘education expenditure of total government expenditure’ indicates the importance of education in the scheme of things before the government.
- (ii) as a percentage of Gross Domestic Product (GDP)
- The percentage of ‘education expenditure of GDP’ expresses how much of our income is being committed to the development of education in the country.
During 1952-2002, education expenditure as percentage of total government expenditure increased from 7.92 to 13.17 and as percentage of GDP increased from 0.64 to 4.02. Throughout this period the increase in education expenditure has not been uniform and there has been irregular rise and fall. To this if we include the private expenditure incurred by individuals and by philanthropic institutions, the total education expenditure should be much higher.
Elementary education takes a major share of total education expenditure and the share of the higher/tertiary education (institutions of higher learning like colleges, polytechnics and universities) is the least. Though, on an average, the government spends less on tertiary education, ‘expenditure per student’ in tertiary education is higher than that of elementary. This does not mean that financial resources should be transferred from tertiary education to elementary education. As we expand school education, we need more teachers who are trained in the higher educational institutions; therefore, expenditure on all levels of education should be increased.
The per capita education expenditure differs considerably across states from as high as Rs 3,440 in Lakshadweep to as low as Rs 386 in Bihar. This leads to differences in educational opportunities and attainments across states.
One can understand the inadequacy of the expenditure on education if we compare it with the desired level of education expenditure as recommended by the various commissions.
- More than 40 years ago, the Education Commission (1964–66) had recommended that at least 6 per cent of GDP be spent on education so as to make a noticeable rate of growth in educational achievements.
- In December 2002, the Government of India, through the 86th Amendment of the Constitution of India, made free and compulsory education a fundamental right of all children in the age group of 6-14 years.
- The Tapas Majumdar Committee, appointed by the Government of India in 1998, estimated an expenditure of around Rs 1.37 lakh crore over 10 years (1998-99 to 2006-07) to bring all Indian children in the age group of 6-14 years under the purview of school education.
Compared to this desired level of education expenditure of around 6 per cent of GDP, the current level of a little over 4 per cent has been quite inadequate. In principle, a goal of 6 per cent needs to be reached—this has been accepted as a must for the coming years.
In the Union Budget 2000-05, the Government of India levied a 2 per cent ‘education cess’ on all union taxes. The government estimated to get a revenue of Rs 4,000-5,000 crore and the entire amount was earmarked for spending on elementary education. In addition to this, the government sanctioned a large outlay for the promotion of higher education and new loan schemes for students to pursue higher education.
Educational Attainment In India
Generally, educational achievements in a country are indicated in terms of adult literacy level, primary education completion rate and youth literacy rate. These statistics for the years 1990 and 2000 are given above in table below.
Education For All — Still A Distant Dream
Though literacy rates for both — adults as well as youth — have increased, still the absolute number of illiterates in India is as much as India’s population was at the time of independence. In 1950, when the Constitution of India was passed by the Constituent Assembly, it was noted in the Directives of the Constitution that the government should provide free and compulsory education for all children up to the age of 14 years within 10 years from the commencement of the Constitution. Had we achieved this, we would have cent per cent literacy by now.
Gender Equity — Better Than Before
The differences in literacy rates between males and females are narrowing signifying a positive development in gender equity; still the need to promote education for women in India is imminent for various reasons such as improving economic independence and social status of women and also because women education makes a favourable impact on fertility rate and health care of women and children. Therefore, we cannot be complacent about the upward movement in the literacy rates and we have miles to go in achieving cent per cent adult literacy.
Higher Education — A Few Takers
The Indian education pyramid is steep indicating lesser and lesser number of people reaching the higher education level. Moreover, the level of unemployment among educated youth is the highest.
As per NSSO data, in 2000, the unemployment rate of educated youth (Secondary Education and above) was 7.1 per cent and unemployment of people with up to primary education was only 1.2 per cent.
Therefore, the government should increase allocation for higher education and also improve the standard of higher education institutions, so that students are imparted employment skills in such institutions.