Human Capital

Human capital is the stock of knowledge, skills, experience and health that makes people productive at work. The term treats education, training and health care as forms of investment: they cost money and time now and raise a person's earnings and output later, much as a machine raises a factory's output. Human capital belongs to the person who has it and cannot be sold separately from them, which sets it apart from physical capital such as capital goods.

The concept underpins much of modern labor economics, growth theory and development policy. It explains why wages rise with schooling and experience, why countries invest in public education, and why economists see health and nutrition as economic as well as social issues. It is related to, but distinct from, intangible assets owned by firms, such as patents and software, and from "social capital", the value of networks and trust.

Imagine two farmers with the same land and the same tractor. One has learned about soil, crop rotation and machinery repair; the other has not. The first gets far more from the same field. What makes the difference sits in the farmer's head and hands, not in the shed.

That know-how took time and effort to build: years of school, an apprenticeship, mistakes along the way. Economists call it human capital because it behaves like other capital. You put resources in, it pays off over many years, and it can wear out if it is not kept up, for example when skills go out of date.

Adam Smith noted in 1776 that a person educated at great expense could be compared to an expensive machine, and that their higher pay should repay the cost. The modern theory was developed at the University of Chicago in the late 1950s and 1960s. Theodore Schultz argued in 1961 that investment in people explained much of US growth; Gary Becker's 1964 book Human Capital set out the theory of how individuals and firms invest in skills, separating general training, useful to many employers, from firm-specific training; and Jacob Mincer linked schooling and experience to earnings. Schultz (1979) and Becker (1992) received the Nobel Memorial Prize in Economic Sciences, in part for this work.

The standard way to measure the payoff from schooling is Mincer's earnings equation:

• $\ln w$ is the natural logarithm of a worker's wage.
• $S$ is years of schooling, and $r$ is the approximate percentage increase in pay for each extra year, the "return to schooling".
• $X$ is years of work experience; $b_1$ is positive and $b_2$ is negative, because pay rises with experience but more slowly over time.
• $a$ is a constant capturing the baseline wage.

For example, if $r = 0.08$, a worker with 16 years of schooling and the same experience as a worker with 12 years has a log wage higher by $4 \times 0.08 = 0.32$. Converting back from logs, $e^{0.32} \approx 1.38$, so the model predicts pay about 38% higher. Large international reviews of such estimates, such as those by George Psacharopoulos and Harry Patrinos for the World Bank, find average returns of roughly 9% per year of schooling, with higher returns in lower-income countries. Estimating these returns well is a classic problem in econometrics, because able people may both stay in school longer and earn more anyway.

At the level of the economy, human capital helps explain differences in productivity and income between countries. In growth accounting, better-educated workers raise output directly, and part of what is left over is counted in total factor productivity. Endogenous growth theory, associated with Robert Lucas and Paul Romer, argues that knowledge and skills have spillovers, so investment in people can sustain long-run growth. Human capital is also central to skill-biased technological change: when technology favours skilled workers, the return to education rises unless the supply of graduates keeps pace.

The World Bank launched a Human Capital Index in 2018, combining child survival, expected years of schooling, test scores and health into an estimate of how productive a child born today will be relative to full education and health. In its 2020 update, the global average child was expected to reach about 56% of their potential. Demographic change matters too: ageing societies rely more on raising the productivity of a shrinking workforce.

• Signaling. Michael Spence's signaling theory, recognized by the 2001 Nobel prize, holds that degrees may raise pay partly by signaling ability to employers rather than by adding skills, which would mean private returns exceed social returns.
• Measurement. Years of schooling are a crude proxy; test-score and quality-adjusted measures can tell a very different story about countries.
• Reductionism. Critics from sociology and the left argue the term treats people as productive inputs and overlooks the non-economic value of education, as well as how family background and discrimination shape access.
• Accounting. Human capital does not appear on company or national balance sheets, so its depreciation, for example during long unemployment spells, is easy to ignore; this links to hysteresis in labor markets.

Human capital is often listed alongside physical capital, land and labor among the factors of production, and its role in pay differences links it to debates on economic inequality and the division of labor.

• World Bank: Human Capital Project
• The Nobel Prize: Gary S. Becker, facts