A Capital Idea?

The HR function has been called many things, some of them not very kind. It’s name has changed over time from personnel to human resources. Some companies are now using the term human capital management.  What is “human capital” and why is the term gaining currency?

As an elementary definition, human capital refers to the people in a company, just like personnel referred to “the body of persons employed in an organization or place of work” and human resources to “the workforce employed by an organization.” However, there is a deeper significance to the term on two different levels.

First, the use of “capital” was intended to put the human resources of a company on a par with other productive resources, especially capital. In some ways this harkened back to the world of classical economists who defined land, labor and capital the factors of production. The importance and influence of capital grew apace since the industrial revolution. The notion that people were the most important asset of a company is a relatively recent one.

Second, human capital is a specific term from the field of labor economics one of whose intellectual pillars is a sub-field within it known as human capital theory. The seminal article in this area, “Investment in Human Capital and Personal Income Distribution” was published by Jacob Mincer in the Journal of Political Economy in 1958. Mincer examined the trade-off between education and earnings in the context of individuals deciding whether it was worth foregoing a few years of wages in order to invest in education with a view to earning a potentially higher wage in the future as a consequence of their enhanced productivity.

Mincer estimated the rate of return on education like an interest rate that would be earned on capital or an internal rate of return on a project. Investing in education or training was therefore akin to investing in one’s own human capital. Firms’ interest in human capital is based on improved productivity from education and training. Mincer’s research showed that annual earnings rose 5-10% in the 50’s and 60’s for each additional year of schooling.

Mincerian wage equations remain an important tool for labor economists. Analytically inclined compensation professionals can use analogous equations to estimate what specific factors drive compensation within a firm. They will find that education and experience play a large role, as should performance, but that other factors may come into play as well (some problematic, such as gender or race). Compensation survey vendors, had they the benefit of access to further information from their participants (e.g., non-benchmark job data, financial data, demographic data) could produce some very useful analytics.

Human capital theory was further developed by Theodore Schultz and Gary Becker through the 50’s and 60’s. Although Mincer was nominated many times, he did not win the Nobel Prize; Schultz won it 1979 for work in economic development and Becker in 1992 in some measure for his work on human capital theory, including his book, Human Capital, published in 1964.

With this context and broadly speaking, human capital refers to the stock of competences and knowledge embodied in the ability to perform work so as to produce economic value. It is the attributes gained by a worker through education and experience. Alternatively, human capital refers to the productive capacities of human beings as income producing agents in the economy.

With this background, it is not surprising that the term human capital has begun to replace human resources and companies are beginning to refer to the area of human resources human capital management (HCM).

There is a contrary point of view that the term “human capital” is dehumanizing. John Picoult, of Watermark Consulting, wrote in the Preoccupations section of the New York Times recently that “People are not equipment. They’re not investment capital. They have needs, wants, aspirations, worries, insecurities and lives outside of work.”

One might argue that it is hard to come up with any label that is not dehumanizing in some respect. Personnel at least had the word “person” in it. Human Resources has the word human in it, but is it right to look at them as objects to be used? Human Subjects certainly wouldn’t do and nor would Human Infrastructure! I think it’s advisable to stay clear of semantics altogether on this topic.

However, Picoult does have a point in terms of the nature of human capital, since recent research in human capital theory recognizes the personality attributes as another dimension of human capital in addition to education and experience. There’s no arguing that such personal characteristics influence individuals’ work and their work environment.



About thenelsontouch

Amit is the founder and managing director of Nelson Touch Consulting, a management consultancy that specializes in maximizing the return on human capital through strategy, incentives and analytics.
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4 Responses to A Capital Idea?

  1. Good blog entry, very interesting how the evolution continues towards finding ways to tie HR back to the organization’s strategic objectives. This underscores the need for incorporating talent analytics data to enable fact-based decision making.

  2. Vic Dayal says:

    Interesting blog, Amit! To take the thought to its next logical step, perhaps there are ways to determine ROHC (return on human capital)… some measure of documenting financial return from the investment in employees’ rewards and education. Perhaps this type of metric can be compared to the financial internal rate of return which investments must meet or exceed, in order to determine which elements of labor cost are efficient and worthy of continued investment.

    • Thanks, Vic. It’s a pretty tricky calculation, unfortunately. An experiment might be to track employees who were invited to participate in a training program and then analyze the pay and career trajectories (in terms of rates or thresholds reached within a certain amount of time) of those that participated and those that did not. You could control for a number of factors that might also influence pay and career growth.

  3. Pingback: Text Analyze This | The Nelson Touch Blog

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