THEORY AND PHILOSOPHY

OF HRD

HUMAN CAPITAL
THEORY

ANUBAMA A/P RAMACHANDRA

860412-43-6282
MH092092
 
 
 
 
NO  TITLE  PAGE NO 

1.0  BACKGROUND OF THE THEORY  1 

2.0  HISTORY OF THE THEORY  2 

3.0  THE THEORY  2 

4.0  THE HUMAN CAPITAL MODEL  3 

5.0  BASIC ASSUMPTIONS  4 

6.0  VARIABLES  4 

7.0  CRITICISM OF THE THEORY  5 

8.0  OTHER IMPORTANT CONCEPT  5 

9.0  REFERENCES  6 

 
 HUMAN CAPITAL THEORY

1.0 Background of the Theory

Human Capital theory has been proposed by Schultz (1961) and developed extensively by
Becker (1964). Becker has explained in his publication titled “Human Capital: A theoritical and
Empirical Analysis to special reference to education” that Human Capital Theory has been
developed in the sixties due to the realization that the growth of physical capital has only small
part of growth in the growth of income. Relatively, the emergence of education and skills
training in millitary technology has also played an important part in the discovery of this theory.

Theodore William Schultz (April 30, 1902 – February 26, 1998) was born in Arlington,
South Dakota, enrolled in South Dakota State College in 1921 to study agriculture, graduated in
1927, then entered the University of Wisconsin-Madison earning his doctorate in economics in
1930. He taught at Iowa State College from 1930 to 1943, and then moved to the University of
Chicago. He later became president of the American Economic Association. He died in
Evanston, Illinois in 1998.

Gary Stanley Becker (born December 2, 1930) is an American economist and a Nobel
laureate. Born in Pottsville, Pennsylvania, Becker earned a B.A. at Princeton University in 1951
and a Ph.D. at The University of Chicago in 1955. He taught at Columbia University from 1957
to 1968, and then returned to The University of Chicago, where he holds joint appointments with
the departments of Economics, Sociology, and the Booth School of Business. Becker won the
John Bates Clark Medal in 1967, was awarded the Nobel Prize in Economics in 1992, and
received the United States' Presidential Medal of Freedom in 2007.

Becker was one of the first economists to branch into what were traditionally considered
topics belonging to sociology, including racial discrimination, crime, family organization, and
drug addiction. He is known for arguing that many different types of human behavior can be
seen as rational and utility maximizing. He is also among the foremost exponents of the study of
human capital.

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2.0 History of the theory

This theory roots from branch of economics, which is Labor Economics. Labor
Economics study is on workforce in general, but the major difference is that it focuses on
quantitative terms, thus has the most accurate predictability than other social sciences. Economist
Theodore Schultz introduced return-on-investment, which highlights the cost-benefit analysis of
training and education. Gary Stanley Becker developed the human capital theory based on
Schutlz’s research on return-on-investment. Becker also introduced the concept of general-
purpose human capital and firm-specific human capital that is widely used by human resource
development practitioners worldwide.

3.0 The theory

According to the theory, Human capital theory suggests that education or training raises
the productivity of workers by imparting useful knowledge and skills, hence raising workers’
future income by increasing their lifetime earnings (Becker, 1994). It postulates that expenditure
on training and education is costly, and should be considered an investment since it is undertaken
with a view to increasing personal incomes.

The human capital approach is often used to explain occupational wage differentials.
Human capital can be viewed in general terms, such as the ability to read and write, or in specific
terms, such as the acquisition of a particular skill with a limited industrial application.

In his view, human capital is similar to "physical means of production", e.g., factories
and machines: one can invest in human capital (via education, training, medical treatment) and
one's outputs depend partly on the rate of return on the human capital one owns. Thus, human
capital is a means of production, into which additional investment yields additional output.
Human capital is substitutable, but not transferable like land, labor, or fixed capital.

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4.0 The Human Capital Model

The human capital model suggests that an individual's decision to invest in training is
based upon an examination of the net present value of the costs and benefits of such an
investment. Individuals are assumed to invest in training during an initial period and receive
returns to the investment in subsequent periods. Workers pay for training by receiving a wage
which is lower than what could be received elsewhere while being trained. Since training is
thought to make workers more productive, workers collect the returns from their investment in
later periods through higher marginal products and higher wages. Human capital models usually
decompose training into specific training, which increases productivity in only one firm, and
general training, which increases productivity in more than one firm. Purely general training is
financed by workers, and the workers receive all of the returns to this training. In contrast,
employees and employers will share in the costs and returns of specific training. Despite these
differences between general and specific training, the model predicts that both forms of training
lower the starting wage and increase wage growth.

Efficacy is the 
Diagram 4.1: The Human Capital Model capacity to 
produce an 
effect 
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5.0 Basic Assumptions

1. Perfect capital markets that denotes free entry to the market

2. Wage is a function of human capital:

Rate of return to human capital 

Stock of human capital 

6.0 Variables

Variables are taken from the equation above:

6.1 Independent Variables

Stock of human capital which includes human capital investment, depreciation /

‘loss’ value, time investment needed to acquire the human capital, and also investment in
goods needed for the human capital investment.

Rates of return on human capital (this varies whether it’s a firm-specific human
capital investment or general human capital investment). A very important thing to note
here is that a general human capital investment provides more return in the long term
typically because during training the employee has to bear all the costs (represented by
the earlier lower wage). However a firm specific human capital investment provides
lower returns because the costs are shared between both the employer and employee.

6.2 Dependent Variables

Wages is considered as dependent variables mainly because it varies according to

the stock of human capital and rate of return to human capital.

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7.0 Criticism of the theory

Block (1990) has argued that Human Capital Theory is a poor concept of capital. It is
unable to understand human activity other than as the exchange of commodities and the notion of
capital employed is purely a quantitative one. This misses the point that capital is an independent
social force where the creation of social value comes about through its capital accumulation.
Given this explanation, human capital is an abstract form of labor - a commodity - and not
capital. Commodities such as human capital are therefore part of the life cycle of capitalism as a
form of labor and not able to be exchanged independently of it.

Another criticism that could be argued here is based on assumption that education in fact
improves productivity and thus could explain higher wages. How true is this assumption? The
theorists clearly did not take into the account of the transfer of learning. Does the duration of
education and training really could increase productivity? Certainly this notion is ideal, but
questionable. A higher productivity indeed does increase the wages. However many other factors
do influence the productivity. There are differences of wages in different regions. The pay also
depends on the kind of industry the employee is in. In some industries, even pay are regulated
by unions.

8.0 Other important concept

8.1 Social Capital

Social contacts affect the productivity of individuals and groups, thus creating the
notion that social network have value. L.J. Hanifan (1916) article regarding local support
for rural schools is one of the first occurrences of the term "social capital" in reference to
social cohesion and personal investment in the community. Similar to human capital,
social capital is not depleted by use, but in fact depleted by non-use ("use it or lose it").

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9.0 References

Becker, G. (1994) Human Capital: A Theoretical and Empirical Analysis With Special Reference

to Education. Chicago: The University of Chicago Press.

Becker, G (1971). Economic Theory. Alfred A. Knopt, Inc.

Becker, G. Human Capital. The Concise Enclyclopedia of Economics.

http://www.econlib.org/library/Enc/HumanCapital.html

Bernarda Zamora. (2007) A new discussion of the human capital theory in the methodology of

scientific research programmes. International Symposium on Economic Theory, Policy

and Applications.

Block, F. (1990) Post Industrial Possibilities: A Critique of Economic Discourse. Los Angeles:

University of California Press.

Cahuc, P. and Zylberberg, A. (2004) Labor Economics, MIT Press

Hanifan, L. J. (1916). The rural school community center. Annals of the American Academy of

Political and Social Science

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Swanson, R.A. and Holton, E.F. Foundations of Human Resource Development. Berret-Koehler

Publishers, Inc.

Veum, J.R (1995) Training, Wages, and the Human Capital Model. Bureau of Labor Statistics,

U.S Department of Labor.

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