What Is the Human Capital Theory and How Is It Used?

What Is Human Capital?

Human capital is a loose term that refers to the educational attainment, knowledge, experience, and skills of an employee. The theory of human capital is relatively new in finance and economics. It states that companies have an incentive to seek productive human capital and to add to the human capital of their existing employees. Put another way, human capital is the concept that recognizes labor capital is not homogeneous.

Key Takeaways

  • Human capital is the intangible economic value of a worker's experience and skills. This includes factors like education, training, intelligence, skills, health, and other things employers value such as loyalty and punctuality.
  • The human capital theory posits that human beings can increase their productive capacity through greater education and skills training.
  • Critics of the theory argue that it is flawed, overly simplistic, and confounds labor with capital.

Understanding the Human Capital Theory

In the 1960s, economists Gary Becker and Theodore Schultz pointed out that education and training were investments that could add to productivity.?? As the world accumulated more and more physical capital, the opportunity cost of going to school declined. Education became an increasingly important component of the workforce. The term was also adopted by corporate finance and became part of intellectual capital, and more broadly as human capital.

Intellectual and human capital are treated as renewable sources of productivity. Organizations try to cultivate these sources, hoping for added innovation or creativity. Sometimes, a business problem requires more than just new machines or more money.

The possible downside of relying too heavily on human capital is that it is portable. Human capital is always owned by the employee, never the employer. Unlike structural capital equipment, a human employee can leave an organization. Most organizations take steps to support their most useful employees to prevent them from leaving for other firms.


The average wage premium for someone with a four-year degree, according to a 2021 study by Georgetown University. The researchers found that someone with a bachelor's degree can earn an average salary 75% higher than the same person with only a high school diploma.

Criticism of the Human Capital Theory

Not all economists agree that human capital directly raises productivity. In 1976, for instance, Harvard economist Richard Freeman argued that human capital only acted as a signal about talent and ability; real productivity came later through training, motivation, and capital equipment. He concluded that human capital should not be considered a factor of production.

Around the same time, Marxian economists Samuel Bowels and Herbert Gintis argued against the human capital theory, stating that turning people (i.e. labor) into capital essentially squashes arguments around class conflict and efforts to empower workers' rights.

In the 1980s and 1990s, with the rise of behavioral economics, new critiques were leveled at the human capital theory in that it relies on the assumption that human beings are rational actors. Therefore, the human capital theory will experience the same defects and limitations when it attempts to explain phenomena because its basic assumptions on human motives, goals, and decisions are, it turns out, not well-grounded.

More modern critiques from sociologists and anthropologists argue against the human capital theory, saying it offers extremely simple principles that purport to explain everyone’s wages, all the time—or, a universal connection between human capital, productivity, and income. But when researchers look closely at this, for the most part, productivity differences between individuals cannot be measured objectively.

One paper, published in 2018, argued that claims of a link between income and productivity relied on circular logic. When scholars limit themselves to the objective measurement of productivity, they find that individual productivity differences are systematically too small to account for levels of income inequality.

What Is Human Capital Management?

According to Automated Data Processing, one of the leading payroll providers in the U.S., human capital management is the process of hiring and managing a workforce effectively. This can include aspects of recruitment and onboarding, as well as end-of-career benefits like retirement and financial planning. It also includes measures to increase the productivity of a workforce through training and talent management.

How Do You Improve Human Capital?

A person can improve their human capital by increasing their education level or learning new skills. Computer programming has become a popular avenue for human capital investments, as the internet reduces the costs and difficulties of learning programming techniques remotely.

How Do Companies Invest in Human Capital?

A common way of investing in human capital is by reskilling or upskilling existing workers. For example, many tech companies offer training programs or tuition reimbursements to encourage existing employees to gain more valuable skills, providing access to an improved labor pool without the expense of recruitment.

The Bottom Line

Human capital is a broad term that refers to the economic value of a person's education, training, skills, and other experiences. While the theory is criticized for being too simplistic, many businesses are seeking to invest in the human capital of their employees in order to become more profitable.

Article Sources
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  1. Gary S. Becker. "Human Capital: A Theoretical and Empirical Analysis, with Special Reference to Education." National Bureau of Economic Research, 1975.

  2. CNBC. "College Is Still Worth It, Researchers Find—Although Some Students Are Still Skeptical."

  3. Richard B. Freeman. "The?Overeducated American." Academic Press,?1976.

  4. Samuel Bowels and Herbert Gintis. "The problem with human capital theory—a Marxian critique."?The American Economic Review,?Volume 65(2), 1975, Pages 74-82.

  5. Blair Fix. "The trouble with human capital theory."

  6. ADP. "What Is Human Capital Management?"

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