Human Capital

Human capital refers to the knowledge, skills, and capabilities of individuals that generate economic output. Human capital averages about two-thirds of the total value of the capital of most economies, which includes land, machinery, and other physical assets as well as the skills and talents of people. The value of human capital is often apparent after physical destruction, as during World War II—many of the German and Japanese cities that were bombed intensely were able to recover 80 to 90 percent of their previous levels of production within months.

More than two centuries ago, Adam Smith observed in Wealth of Nations (1776) that an educated man must earn more than "common labor" to "replace to him the whole expense of his education." Human capital was first discussed extensively by two Nobel Prize–winning economists, Theodore Schultz (1979) and Gary Becker (1992), to explain how any personal decision to sacrifice today for a return tomorrow can be analyzed in the same way that a business considers an investment decision, such as whether to buy new machinery. A nation's stock of human capital and thus its economic growth potential could be increased, they reasoned, if governments reduced the cost and increased the benefits of schooling, the human capital embodied in individuals.

Human capital is rented in the labor market rather than "sold." Individuals exchange effort for reward, and acquire human capital in the expectation that their incomes will be higher. Human capital takes time to acquire, and the basic model of human capital acquisition compares the income stream from going to school with that of going to work immediately. The costs of going to school include the direct costs, in the form of tuition and books, as well as the indirect costs, the forgone earnings that could have been received from working. The benefits of more schooling are higher earnings in the future.