Saturday, February 25, 2017

Why human capital is capital

Economists tend to use the word "capital" pretty loosely. It just means "anything you can spend resources to build, which lasts a long time, and which also can be used to produce value." That's really broad. For example, it could include society itself. It also typically includes "human capital," which refers to people's skills, talents, and knowledge.

Why do most economists define "capital" this way? Really, it's just a convenient way to make the kind of models they like to make. I tried to explain this in a wonky post a couple of years ago.

But there are people out there who really don't like this broad definition of "capital". For example, the economist Branko Milanovic has repeatedly argued against use of the term. So has Matt Bruenig. And Paul Krugman agrees with them. They would rather restrict the word to mean what economists typically call "physical capital" - machines, buildings, and the like.

Who's right? In general, I don't like to boss anyone around with regards to vocab choices. Use words the way you want to use them, and just let people know what you mean. I would personally have preferred a different term, like "skill capital". But I think the term "human capital" is useful because it helps to convey some important truths about the world. Here are some facts about the world that I think the term "human capital" helps remind us of:

1. It's worse to be uneducated, unskilled and poor than to be educated, skilled and "poor".

Imagine that you're 22, educated, and poor. You have a bunch of student loan debt, but no money in the bank. You have book learning and credentials, but no immediately employable skills, very little on your resume, and not much of a network. You're sleeping in your friend's spare room and buying the cheapest food you can find.

Congratulations, you're me! Was I poor? By many measures, yes. But I certainly didn't feel poor. I knew that my Stanford degree and general intellectual skill (I could do math well and write well) would eventually let me get a good-paying job. In fact, I had no qualms whatsoever about my economic future. Zero fear.

But imagine yourself in the same situation with no degree, and without that general writing and math skill. Imagine yourself as a 22-year-old with the same debt and the same empty bank account. What are your future employment prospects? Construction worker? Landscaper? Day laborer?

The second way is a much worse way to be, right? Both 22-year-olds, me and my hypothetical uneducated counterpart, have the same official amounts of wealth. But despite the fact that I was scrounging for cheap food and sleeping in a friend's spare room, I didn't really feel like a poor person, and with good reason - I knew my future wasn't a future of poverty.

The word "human capital" gets at this distinction. It's a way of saying "education and skills are a form of wealth." If you ignore this wealth, you end up treating penniless grad students the same as honest-to-goodness poor people.

2. Some people make more money than others from the same amount of labor.

Opponents of the term "human capital" tend to say that human capital is really just labor. They like to define "capital" as anything that gives you passive income - in other words, anything that gives you money without work.

But consider me vs. an uneducated grocery store worker the same age as me. I don't work any harder than a grocery store worker - less hard, if the truth be told. I get up, read books, read papers, read Twitter and the news. I write some articles. The grocery store worker is moving groceries from the stock room to the shelves and back, checking inventory, working the cash register, answering people's questions, etc. Who is putting in more labor input, more effort and strain? Probably the grocery store worker.

But, as I'm slightly ashamed to admit, I make more money.

I view that difference as a form of passive income. Without spending any more effort than my grocery store worker counterpart, I get more money. This is just as passive as owning stocks, bonds, or real estate. My education and my skills (and my human networks, and my knowledge of the labor market) are a form of wealth that delivers me income for no extra effort.

It makes sense to me to have a word for this other sort of passive income-earning power. And "human capital" refers to exactly that.

3. Government spending on education represents investment for the future.

Government pays lots of money to educate the populace. We have universal public school. We have state-supported universities and colleges. Families themselves pay a lot on top of that, for university tuition, room and board, tutors, etc.

Is that spending a form of consumption? Is it just fancy day-care and subsidized partying? Some cynics would say yes, but I think the answer is very clearly no. A lot of that spending represents an investment in the future. The spending today will pay off tomorrow, in the form of a more productive populace.

When you spend money today and get back more than you spent, I say you're building wealth. And "capital" is really the same thing as "wealth" - it's the ownership of something that can deliver you income (passively!) in the future. Education creates no physical stores of value - no trucks or buildings or machine tools. But skills and knowledge are durable - you remember how to program a computer, or how to think like a lawyer.

When investment creates durable stores of value that produce income in the future, it makes sense to me to call it "capital". In my opinion, one big problem in the United States is that government doesn't invest enough. I think that depicting education spending as an investment in productive capital is helpful for making the case that government should spend more on education.

So there are three reasons why it often makes sense to think of skills and education as a form of capital. What about the objections? One objection people give is that income from human capital isn't passive - but, as I explained in point 2, it really is passive, since it allows you to get more income without any more effort - or the same amount of income for less effort.

A second objection is that people's education and skills can't be bought and sold, because we don't have indentured servitude. That's basically true (though there are some gray areas, like long-term contracts, noncompete agreements, or wage garnishment for student loans). But that's just a law. We could easily pass a law saying that office buildings can never ever be bought or sold, but must be owned forever by the people or companies that built them in the first place. Under this law, they could only be rented out, and only using month-to-month leases.

Would that law make office buildings any less a form of "capital"? I say no. By the same token, laws against indentured servitude change how human capital gets used in the economy, but they don't really change what it is. I strongly support laws against indentured servitude. But they don't change anything about the physical nature of education and skills. They don't change the fact that these are durable investments that produce passive income.

So by using the term "human capital", we remind people of several important truths:

1. We remind people that educated "poor" people aren't really as poor as uneducated poor people.

2. We remind people that skilled workers don't really work harder than unskilled workers.

3. We remind people that government spending on education is an investment for the future.

I think those are good and important things to keep in mind.


  1. A defining feature of capital is that it's pareto improving. If you add one piece of machine and it doesn't increase output it's not really capital, it's just a useless piece of junk.

    So when you call education human capital, you're making the assumption that education is pareto improving and that it's neither signaling nor a positional good.

    You can well see the political implication of this and why left wingers don't like it. If the extra income you gain from your degree derives only from the extra wealth you've created then you're entitled to keeping it entirely. You've made it, it's yours.

    But if your degree just gets you the job that an uneducated worker would have gotten otherwise, then you don't really deserve it.

  2. I've never heard of capital as a pareto-improving. If it is, it's certainly dependent on its correct use/positioning. A chainsaw is undeniably a piece of capital, but I don't expect it would be a pareto-improvement to stick it in the middle of an aircraft engine.

    If you're really insistent on that criteria, virtually any education could improve *some* task if properly applied.

  3. I've always said that "human capital" and "physical capital" share three important characteristics:
    1) The are both costly to acquire.
    2) They are both durable.
    3) They both depreciate.

    And, of course, they differ in a number of ways as well (I can sell any physical capital I own, but I cannot sell--transfer possession at a price--the human capital I own, for example.)

  4. Human capital isn't just about skills, it's also about health. If you want to hire able bodied workers, making sure they are fed properly and protected from disease when they are young means they can do heavier work and have more stamina. I always heard they sold the school lunch program after they saw the crappy state of recruits in the first world war. Better nourished humans with access to medical care will also be less susceptible to disease. Properly nourished, healthy people also find it easier to acquire new skills and work longer, so there is more flexibility and a longer payback period. Governments should run a human capital budget.

    This make sense from a biological point of view. Organisms have energy, time and nutrient budgets. There's a whole branch of biology that deals with bio-energetics, disease cost and food foraging strategies from an economic point of view. When should a plant tell its flowers to bloom? What sex ratio is best for a lizard's children? How long should bees forage before returning to the hive? These are effectively economic decisions, and it might help economists to study these fields to get a better sense of how human biological organisms make their decisions.

    1. Not sure health and education are really the same in this respect. If education is investment and the creation of capital, then proper nourishment is more like maintenance and the administration of medical care is like repair. These are important, for sure, but from an economic perspective they're not investment in capital.

  5. I think that resistance to using the term "human capital" is much like resistance to calling corporations "persons": It blurs the line between the economic and the social, in a manner that almost inevitably decreases the value and dignity of the person. Is it technically wrong to call a worker an "asset" for a company? Probably not -- but it certainly strikes a sour chord. I don't think it's worth fighting total war over, but the term is loaded with connotations beyond its technical meaning, and that engenders the resistance.

    1. I think this is an excellent point

  6. "The word "human capital" gets at this distinction. It's a way of saying "education and skills are a form of wealth." If you ignore this wealth, you end up treating penniless grad students the same as honest-to-goodness poor people."

    The same distinction can be made e.g. between a penniless white person of high social class, and a person of color or an educated immigrant.

    I wonder then to what extent racial or sociocultural categories can be forms of capital.

    1. important question.

    2. Depends on the extent that the productivity of the compared workers depends on some other persons perception of their productivity. Is it right to do that? No. But it is rational in some myopic sense to employ the white worker..

  7. I was thinking about this article today and it struck me that different kinds of capital can have different kinds of value in different times based upon their relative longevity. In a world of rapid technological change there is a much shorter half life on skill capital and therefore a decrease in its valuation as opposed to other kinds of capital like maybe land?

  8. Unless its fungible, there is no point in calling skill or education "capital" and quite a bit of mischief to be done. Only the odd rock star or athlete has been able to capitalize future income streams. If you can capitalize expected future income, go ahead and call it capital. If you can't, don't.

  9. Even with indentured servitude, you can't split "human capital" from "labour" (while you can have a car and hire - and fire - a driver); I think this made "human capital" much different from traditional capital (for example, one of the implications is that "human capital" can't be accumulated by one person to be used by other)

  10. Ricardo and Marx had the right solution for the question. They explain the wage distribution according to skills (today it would be a little more complicated, but IMO, the reasoning is correct). And yet, they don't mix skills with "capital". Just take whatever you think differentiates the skilled worker from the unskilled one, and use it to explain wage differences. Because, if words actually matter for something, the difference is not "capital", it may well be called "rent". And yet, nobody speaks of "human rent".

  11. The truly interesting thing about this is that if human capital is indeed capital then all of Piketty's whining about the distribution of wealth rather goes away, doesn't it? Because human capital is rather larger than the pittance we have of financial wealth...

    1. Though I think Piketty is probably wrong, I also think human capital doesn't kill his theory. The returns to human capital (higher income) are typically reinvested in financial assets.

    2. Poor people lack human and physical capital.

      Middle class people lack physical capital, but have human capital.

      Rich people have physical and human capital. (Lottery winners and lazy heirs may lack human capital)

  12. "We remind people that skilled workers don't really work harder than unskilled workers."

    This has to be one of the most unappreciated facts in America today. Personally I'd put it even more strongly: in the large, skilled workers don't work as hard as unskilled workers

  13. To the person in the street, "capital" is just money or wealth, which you sort of fall into briefly there, Noah. Of course economists recognize this but clarify it by adding "financial" in front of "capital" to distinguish from that good old "produced means of production."

    And, of course, for Marx, capital is a social relation, not a pile of machinery or education or money, per se.

    1. I think to the person in the street, "capital" means nothing except Washington, D.C.

  14. I think that conflating "passive" with "no effort in addition to the effort someone else is putting forward" is completely unpersuasive. If you, with your skills, were paid more than someone who was not working, even though you are not working any more or any harder than them, then you'd have a passive human capital income. But that's not how human capital works: you still need to work in order for it to produce a return. But financial or physical capital that you acquire with those returns, those can keep earning returns without any additional effort on your part. Branko has you on this one.

    Separately, I think you missed an important feature of proper capital: that it can serve as collateral. I would argue that human capital cannot be pledged in the way that physical and financial capital can be, and this has important consequences for, say, the viability of worker owned enterprises (this is an old Bowles/Gintis argument, by the way).

    1. I think that conflating "passive" with "no effort in addition to the effort someone else is putting forward" is completely unpersuasive.

      I work no harder; I get lots more income. Where does the difference come from? Did I work for the difference? Not if work=effort, I didn't. Since "passive" means "no effort required", I got that extra bonus with no effort. So it's passive income.

      As for human capital being used as collateral, this was going to be another point in my list but I deleted it. The fact that student loans have lower interest rates than student credit cards, combined with banks' ability to garnish your wages if you don't pay your student loans back, act a lot like a collateral system.

    2. A man with a shovel is more productive than one without, but doesn't necessarily work harder.

  15. Adam Smith explained profits, interest, and rent as value added not paid out in wages. Those who understand this have argued about whether there is something in theory that distinguishes the exploitation of labor from, say, the exploitation of corn.

    I suggest that literature exploring these questions addresses the subject matter in the OP.

  16. Anonymous12:32 PM

    Good summary and examples. I really like how you added connections to information as human capital which is often missed by people.

    I would also add branding/reputation.