What is human capital? Definition and meaning

Human capital refers to the factors of production, coming from human beings, used to create goods and services. Our knowledge, skills, habits, social and personality attributes, including creativity, all form part of the human capital that contributes to the creation of goods and services. Factors of production are the four inputs required for the production of goods and services.

In other words, human capital is the collection of all our resources – all our knowledge, abilities, talents, skills, intelligence, training, judgment, experience, and wisdom, possessed individually and collectively.

In a country, the term refers to how its population contributes towards wealth creation.

Capital refers to things made by humans that make other things, like machinery and equipment. Human capital may refer to investments made into human beings to improve production, like education, skills, experience, etc.

Human CapitalAlternatively, human capital refers to things thrown into human beings in order to make them more productive.

According to Encyclopaedia Britannica:

“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.”

Human capital contrasts with social capital, which looks at the value of the network of relationships between people, groups and entities.

Human capital – people’s value throughout their career

Human capital also refers to the value of a person for a company in terms of being able to produce goods or provide services during the time span of their career.

While putting a monetary value directly on human capital is not possible, businesses and economists commonly measure the value of human capital as the current value of an individual’s future wage and salary income.

For example (example quoted from the Financial Times), if Mary Smith were beginning a 45-year career with a starting salary of $40,000, and expected her salary to increase annually by 3% (average), then using an 8% rate for the time value of money, this individual’s human capital at the beginning of her career would be $705,224.

The human capital value of most college graduates generally exceeds $1 million.

As we get older our human value rises, because over time we acquire more knowledge and skills, but our human capital value declines, because there is less time left before we retire.

When people retire and give up any future employment, their human value (as it is normally measured) drops to zero.

Our human capital is our single most valuable asset. We should all protect it with disability income insurance and life insurance.

Examples of human capital include a professional football (US: soccer) player’s ability to score goals, a software engineer’s skill in writing computer programs, an opera singer’s beautiful voice, and a doctor’s accuracy and speed in diagnosing ailments in patients.

Two kinds of human capital

There are two kinds of human capital: general and specific.

General: this refers to knowledge and skills that several different employers find useful, such as expertise in accountancy, marketing or personnel management.

Specific: skills that only one employer might be interested in. For example, John Doe Cranes Inc. has proprietary equipment that can only be operated by people with special training. Those with that training will only be of interest to John Doe Cranes Inc.

Quotes

Warren Buffett, an American business magnate, investor and philanthropist, often quoted as the most successful investor of the 20th century, said the following about human capital:

“Investing in yourself is the best thing you can do. Anything that improves your own talents, nobody can tax it or take it away from you. They can run up huge deficits and the dollar can become worth far less. You can have all kinds of things happen. But if you’ve got talent yourself, and you’ve maximized that talent, you’ve got a tremendous asset that can return ten-fold.”

Gary Becker (1930-2014), an American economist who made major contributions to the family economics branch of economics, said:

“My work on human capital began with an effort to calculate both private and social rates of return to men, women, blacks, and other groups from investments in different levels of education.”

Vicente Fox, former President of Mexico, said:

“I believe Mexico should dedicate 100% of its oil revenues to developing human capital and technological development. None of us politicians should be able to touch that money.”

Video – Human capital

In this Khan Academy video, the speaker explains that human capital are the investments made into human beings in order to make them more productive.