Businesses require a few inputs to produce anything, namely, land, capital, labor, and money. To cite my definition of capital:
“In economics, capital refers to any non-financial asset that can be used towards production… A factory owner would possess capital like machinery, generators, and other technology. A corporation would have capital like computers, copiers, and software.”
Notably, labor (employees) is not capital. Capital is an important part of any production function, which is a fancy term for your methods of achieving an end goal. We could create a production function for virtually anything. Imagine a production function for making pancakes—it would look a lot more like a recipe than an industrial formula. That’s all a production formula really is, though—a glorified recipe. As mentioned in the capital definition, capital tends to depreciate over time (just like ingredients for a recipe might), and the outcome of a production function can heavily depend on capital and quality of labor.
How do we measure the quality of labor?
Labor is human capital. Humans have a measurable value when it comes to production, and we typically measure the effectiveness of labor in terms of productivity. Just as a business needs certain capital to succeed, a human has capital that can be improved through investment and determines their ability to be productive. Some common components of human capital are education, training, intelligence, and health.
Human capital then becomes an aggregated sum of one’s worth in the workforce. The more education, training, and brainpower one has, the more they will be able to “produce” in their job—whether that is cold-calling people, creating marketing materials, or constructing financial models. Human capital is, quite literally, a recipe for success. Like capital, human capital may depreciate over time without additional investment. At the end of the day, we all age, and most lose some of their memory or hard technical skills.
Unlike a baking recipe, the inputs for human capital are not fixed. One can almost indefinitely pursue more education and training, though the value of doing so will diminish as the sum increases.* For example, take the expected gains in salary and productivity seen at different levels of education. An individual who has only completed high school stands to experience a huge increase in human capital by finishing a college degree. On the other hand, someone with 2 PhD’s will probably receive no substantial gains by finishing a third.
Unexpected qualities can affect human capital—emotional stability, physical health, and even physical appearance can all make an individual a more appealing worker. Employers and the government also have the ability to improve human capital. Many companies provide extensive employee training or pay for graduate school, both of which are mutually beneficial. The government has the most pronounced ability to affect human capital, as it controls the educational system. Without a strong foundation of knowledge and reasoning abilities, building future human capital will prove nigh impossible.
Due to the dependence of human capital upon early education and development, one’s ability to succeed in the future is pre-determined from a young age. Now, this isn’t a determination about if they will or will not succeed, rather, an assessment of how much potential they have to grow and move upwards.
The concept of human capital as a value in flux is quite interesting; it indicates at any given time an individual may be sitting at a certain point on the scale of their potential human capital.
What remains unclear is how much of one’s potential human capital (or current human capital) is pre-determined at birth. People do not like to believe that their life outcome was determined in utero, and for good reason—it makes them feel helpless in the grand scheme of it all. Thomas Piketty’s Capital in the 21st Century analyzed the tendency of wealth to accumulate over time, but as an insightful Bloomberg article points out, failed to acknowledge the more insidious perpetrator of inequality—disparities in education translating to lower life attainment. Children born into wealthier families often receive more early childhood development, which can range from playing Mozart for baby to reading books every night. When individuals without a great deal of education (reduced human capital) have children, they may not be aware of best practices for raising a little Einstein. As early child development is one of the single most important determinants of success, this can set up the children of those with low human capital to have low human capital as well.
While this can seem to be a depressing fact of the cyclical nature of inequality, but I find it to be quite heartening—it means that increasing future generations’ opportunity depends on tangible educational means and government programs rather than throwing our hands up in the air and praying. Society has control through their votes to promote more equal development of early human capital by voting for better education and early childhood programs. Whether individuals choose to pursue the opportunities given to them remains in their hands, but by giving more children the chance to do so, society benefits as a whole.
Human capital is the aggregate value of a worker as determined by their education, training, intelligence, and more. The concept of human capital indicates that while mobility and access to human capital’s inputs may be limited by socio-economic status, one can improve their holistic value through self-investment.
*Assuming your current level of human capital is t, an additional unit of investment (t+1) will become less valuable as t grows larger. This idea applies to capital as well. A company that continues buying machinery without expanding any of it’s other components (labor, land) will ultimately be decreasing in efficiency.