What Is the Relationship Between Human Capital and Economic Growth?

Human capital and economic growth have a strong correlation. Human capital affects economic growth and can help to develop an economy by expanding the knowledge and skills of its people.

Key Takeaways

  • Human capital affects economic growth and can help to develop an economy by expanding the knowledge and skills of its people.
  • The level of economic growth driven by consumer spending and business investment determines the amount of skilled labor needed.
  • Investing in workers has had a track record of creating better employment conditions in economies throughout the world.

Understanding Human Capital and Economic Growth

Human capital refers to the knowledge, skill sets, and experience that workers have in an economy. The skills provide economic value since a knowledgeable workforce can lead to increased productivity. The concept of human capital is the realization that not everyone has the same skill sets or knowledge. Also, the quality of work can be improved by investing in people's education.

Economic growth is an increase in an economy's ability, compared to past periods, to produce goods and services. Economic growth is measured by the change in the gross domestic product (GDP) of a country. GDP is a representation of the total output of goods and services for an economy. For example, if a country has a GDP rate of 2.5% for the year, it means the economic growth of the country rose by 2.5% from a year earlier.

Two Key Drivers of Economic Growth

In order to determine how human capital impacts growth, we must first look at two key drivers of economic growth in an economy: consumer spending and business investment.

Consumer Spending

It's estimated that consumers are responsible for more than two-thirds of the economic growth in the U.S. economy. As consumers become employed or experience wage increases, they tend to increase their purchases of clothes, cars, technology, homes, and home goods such as appliances. All of that spending creates a positive ripple effect leading to improved employment in various industries such as retail, auto manufacturers, technology stores, and home builders, to name a few. The spending also leads to higher GDP growth throughout the economy.

Business Investment

The increased GDP growth from consumer spending leads to improvements in business conditions. As companies become more profitable, they tend to invest more money into their businesses to create future growth. Business investment can include new equipment and technology purchases. The investments businesses make are called capital investments. Capital investments, which require large outlays of capital or cash, are designed to boost a company's productivity and profits in the long term.

In a growing economy, companies also take on additional borrowing from banks to expand production due to higher consumer demand. The loan proceeds are usually used for large purchases of assets such as manufacturing plants and equipment. The added production also leads to higher wages and increased employment as more workers are needed for the increase in consumer demand for a company's products.

As companies look to hire workers to help with the increase in sales, it leads to new job openings in various types of employment. However, if the labor market becomes too tight, due to an expanding economy, companies are forced to train workers for the skillsets needed since there aren't enough available skilled workers.

As a result of business investment, companies are more productive, while GDP growth rises since business investment is a key component of growth. Both consumer spending and business investment not only lead to more economic growth but also play a prominent role in determining the level of training and development of workers.

Investments in Human Capital

Human capital is positively correlated to economic growth since investment tends to boost productivity. The process of educating a workforce is a type of investment, but instead of capital investment such as equipment, the investment is in human capital.

Government Investment

The role of governments is key to expanding the skillsets and education levels of a country's population. Some governments are actively involved in improving human capital by offering higher education to people at no cost. These governments realize that the knowledge people gain through education helps develop an economy and boost economic growth. Workers with more education or better skills tend to have higher earnings, which, in turn, increases economic growth through additional consumer spending.

Corporate Investment

Companies also invest in human capital to boost profits and productivity. For example, let's say an employee working?at a technology company receives training to be a computer programmer through on-site training and in-house seminars. The company pays for a portion of the tuition for higher education. If the worker remains at the company after the training has been completed, they may develop new ideas and new products for the company. The employee might also leave the company later in their career and use the knowledge they learned to start a new company.

Whether the employee remains at the firm or starts a new company, the initial investment in human capital will?ultimately lead?to economic growth.

How Education Increases Economic Growth

Investing in workers has had a track record of creating better employment conditions in economies throughout the world. If employment is improving, consumer spending rises, leading to increased revenue for companies and additional business investment. As a result, employment is a key indicator or metric for determining how GDP growth may perform.

The Organisation for Economic Co-operation and Development (OECD) is a group of more than 30 member countries that help to shape and develop economic and social policies across the globe.

OECD routinely analyzes the impact of education levels on employment and ultimately, economic growth. The OECD's 2022 annual Education at a Glance?report reviewed how education systems operate, the level of spending, and who benefited or participated. The OECD also measures how increases in education for men and women drive employment growth.?

The OECD found that in 2021, countries with people who had grammar and high school educations experienced an employment rate among 25-34 year-olds of 83% for men and 67% for women. However, those who had college or graduate education levels experienced an employment rate of 88% for men and 82% for women.

Although investment in human capital tends to produce more growth, it doesn't necessarily mean the jobs are available for the newly-educated workers. Also, geography plays a role when it comes to job openings and the movement of labor. If job openings are located in the northern part of a country, but the skilled labor is in the south, growth could be hindered due to the cost of moving or the lack of desire to move.

Why Does Human Capital Matter to an Economy?

The knowledge, skills, and creativity of a company's human capital is a key driver of productivity. Developing human capital allows an economy to increase production and spur growth.

What Are the Economic Benefits of Human Capital?

Investing in human capital tends to increase innovation, boost production, and improve profitability, all of which lead to economic growth.

What Are the Benefits of Economic Growth?

With economic growth, production increases, which in turn increases the demand for labor, decreasing unemployment. It also tends to decrease poverty and improve the standard of living.

The Bottom Line

Human capital refers to the knowledge, skills, and abilities of workers. Overall, an economy tends to grow when it invests in the development of its people. Economic growth in turn tends to lift more people out of poverty and improve living conditions.

Article Sources
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  1. Federal Reserve Bank of St. Louis. "Shares of Gross Domestic Product: Personal Consumption Expenditures."

  2. The Organisation for Economic Co-operation and Development. "Where: Global Reach."

  3. Organisation for Economic Co-operation and Development. "Education at a Glance 2022."

  4. Organisation for Economic Co-operation and Development. "Education at a Glance 2022," Page 78.

  5. OECD. "Building Jobs and Prosperity in Developing Countries," page 3.

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