Chapter - 6

HUMAN CAPITAL FORMATION

Human resources are vital from the point of view of economic development. In the modern world, all the
planners believe that the building of a strong nation depends upon development of people and the organization
of human activity. If this resource is developed properly, it can do wonders. The development of human
resources means increase in the quality of human beings, which helps in the process of growth and development
of the economy.
In the words of Prof. Whipple, “ A nation’s true wealth is neither in its land and water, nor in forests, nor in
its flock and herds, nor in dollars in its wealthy and happy men, women and children.”
Physical Capital and Human Capital
The economic development of a country is possible only when there is optimum utilization of physical and
human resources.
1. Physical Capital: it includes all those inputs which are required for further production, like plant and
machinery, factory, buildings, raw materials, etc.
 The physical capital is needed to make use of physical resources.
 Its accumulation is quite important for economic growth of a country.
 The ownership of physical capital is the outcome of the conscious decision of the owner. The entrepreneur
possesses knowledge to calculate the expected rates of return to a range of investments and then rationally
decides which one of the investments should be made.
 The physical capital formation is mainly an economic and technical process.
2. Human Capital: It refers to the stock of skill, ability, expertise, education and knowledge embodied in
the people.
 Human Capital is needed to make effective use of physical capital.
 There is a need for investment in human capital to produce more human capital out of human resources.
 Societies and sufficient human capital in the form of competent people who have themselves been
educated and trained as professors and other professionals. In other words, we need good human capital to
produce other human capital (say, doctors, engineers, etc.)
A country can turn physical resources like land into physical capital like factories. Similarly, it can also turn
human resources like students into human capital like engineers and doctors. Both the forms of capital
formation are outcomes of conscious investment decisions.

Human Capital creates both Private and Social Benefits

Nature of benefits from human capital, are different from that of physical capital,
 Human Capital benefits not only the owner but also the society in general. For example, an educated
person can effectively take part in a democratic process and contribute to the socio-economic progress of a
nation. Similarly, a healthy person prevents spreading of contagious diseases and epidemics by
maintaining personal hygiene and sanitation. Thus human capital creates both private and social benefits.
 On the other hand, Physical Capital creates only private benefit. It happens because, benefits from a
capital good flow to those who pay the price for the produced by it.

Comparison Between Physical and Human Capital

S. No. Physical Capital Human Capital
1. Physical capital is tangible and can be easily Human capital is intangible and cannot be
sold in the market. sold in the market.
2. It depreciates with the passage of mine. Depreciation in human capital can be reduced
by making continuous investments in
education and health.

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 3. It is more mobile between countries. Human capitals is less mobile between
countries as compared to physical capital.
4. Physical capital (like machinery) can be Human capitals (like skills of a person)
separated from its owner. cannot be separated from the owner.
5. Physical capitals is the outcome of conscious Formation of human capital is partly a social
decision of owner and is mainly an economic process and partly a conscious decision of the
and technical process. possessor of the human capital.
6. It can be built through imports. Human capital formation is to be done
through conscious policy formulations.

HOW PEOPLE BECOME RESOURCE ?

People become resource by using their skills, knowledge, productivity and abilities. When human resource is
further developed by becoming more educated and healthy.

MEANING OF HUMAN CAPITAL FORMATION (HCF)

Human Capital Formation refers to development of abilities and skills among the population of the country;
 It is the process of acquiring and increasing the number of persons, who have the skills, education and
experience.
 Human capital formation is associated with investment in man and his development as creative and
productive resources.

SOURCES OF HUMAN CAPITAL FORMATION

There are a number of ways by which human capital can be increased. The different sources of human capital
formation are;
1. Expenditure on Education: Proper utility of manpower depends on the system of education and training of
people.
 Labour skill of an educated person is more than that of an uneducated person, which enables him to
generate more income than the uneducated person. Economists have stressed the need for expanding
educational opportunities in a nation as it accelerates the development process.
 Spending on education by individuals is similar to spending on capital goods by companies. Individuals
invest in education to increase their future income and raise the living standard.
 Education contributes to economic growth
(i) Education confers higher earning capacity on people;
(ii) It gives better social standing and pride;
(iii) It enables one to make better choices in life;
(iv) It provides knowledge to understand the changes taking place in society;
(v) It also stimulates innovations;
(vi) It facilitates adaptation of new technologies.
2. Expenditure on Health: Health - expenditure is a source of human capital formation as it directly increases
the supply of healthy labour force.
 Poor health and undernourishment adversely affect the quality of manpower. A sick labour, without
access to medical facilities, is compelled to abstain from work and there is loss of productivity.
 Therefore, expenditure on health is important to build and maintain productive labour force and to
improve quality of life of people in the society.
 Adequate food and proper nourishment to people, along with adequate health and sanitation facilities
leads to qualitative improvement in human capital.
 Forms of health Expenditure: The various forms of health expenditures include;
(i) Preventive Medicine Known as vaccination;
(ii) Curative Medicine, i.e., medical intervention during illness;
(iii) Social Medicine, i.e., spread of health literacy;
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 (iv) Provision of clean drinking water.
(v) Good Sanitation facilities.
3. On-the-Job-Training: Productivity of physical capital is substantially enhanced with the improvement in
human capital. Due to this reason, many firms provide on- the-job training to their workers.
 Such training has the advantage that it can be provided fast and without much cost.
 It increases the skill and efficiency of the workers and leads to an increase in production and
productivity.
 On-the-job-training may take different forms:
(i) Workers may be trained in the form itself under the supervision of a skilled worker;
(ii) Workers may be sent for off campus training.
 After on-the-job-training of employees, firm insist that the workers should work for a specific period
of time, so that it can cover the benefits of the enhanced productivity owing to the training.
 It is a source of human capital formation as return of expenditure on such training, in the form of
enhanced labour productivity, is more than the cost of it.
4. Expenditure on Migration: People migrate from one place to another in search of jobs that fetch them
higher salaries.
 Unemployed people from rural areas migrate to urban areas in search of jobs.
 Technically qualified persons (like engineers, doctors, etc.) migrate to other countries because of
higher salaries that they may get in such countries.
 Migration in both these cases involves two kinds of cost:
(i) Cost of transportation from one place to another; and
(ii) Higher cost of living in the migrated places.
 Expenditure on migration is a source of human capital formation as enhanced earnings in the migrated
place is more than the increase in costs due to migration.
5. Expenditure on Information: Expenditure is incurred to acquire information relating to labour market and
other markets.
 It involves amount spent on seeking information about educational institutions, their educational
standards and cost of education.
 For example, people want to know the level of salaries associated with various types of jobs, whether
the educational institutions provide the right type of employable skills and at what cost.
 Information is necessary to make decisions regarding investments in human capital as well as for
efficient utilization of the acquired human capital stock.

HUMAN CAPITAL AND ECONOMIC GROWTH

Economic growth means the increase in real national income of a country.
 The contribution of an educated person to the economic growth is more than that of an illiterate person.
 Similarly, a healthy person also contributes to economic growth by providing uninterrupted labour
supply for a longer period of time.
Thus, both education and health, along with many other factors like on-the-job training, job market information
and migration, increases the income generating capacity of an individual.

HCF promotes inventions, innovations and technological improvements

The human capital formation (HCF) not only increases the productivity of human resources but also stimulates
innovations and creates ability to absorb new technologies.
 Education provides knowledge to understand changes in society and scientific advancements, thus,
facilitate inventions and innovations.
 Similarly, the availability of educated labour force facilities adaptation to new technologies.

Difficulty to prove Cause and Effect relation between Human Capital and Economic Growth
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Due to measurement problems, it is difficult to prove that increase in human capital causes economic growth.
 For example, education measured in terms of years of schooling, teacher-pupil ratio and enrolment rates
may not reflect the quality of education.
 Similarly, health services measured in monetary terms, life expectancy and mortality rates may not reflect
the true health status of the people in a country.
It means, it is difficult to establish a relation of cause and effect from the growth of human capital (education
and health) to economic growth. The relationship between human capital and economic growth flows in either
directions.
 Higher income causes building of high level of human capital; and
 High level of human capital causes growth of income.
Development Indicators in Education and Health Sectors
Indicators of Development in Education and Health Sectors.
Particulars 1951 1981 1991 2001 2014-15

Real Per Capita Income (in ₨) 7,651 12,174 15,748 23,095 72,900

Crude Death Rate (Per 1,000 25.10 12.50 9.80 8.10 6.70
Population)

Infant Mortality Rate 146 110 80 63 37

Life Expectancy Of Males at Birth (in 37.20 54.10 59.70 63.90 67

years)

Life Expectancy of Females at Birth 36.20 54.70 60.90 66.90 70

(in years)

Literacy Rate (per cent) 18.33 43.57 52.21 65.20 76

Report by Deutsche Bank and World Bank

Two independent reports on the Indian economy have identified that India would grow faster due to its strength
in human capital formation.
(i) Report by Deutsche Bank: The Deutsche bank (a German Bank), in its report on “Global Growth
Centres”, identified that India will emerge as one among four major growth centres in the world by the
year 2020.
 It further states that human capital is the most important factor of production in today’s economics.
Increase in human capital is crucial to achieve increase in GDP.
 With reference to India, it states that between 2005 and 2020, a 40 % rise in the average years of education
in India is expected.
(ii) Report by World Bank: The recent report of world bank “India and the knowledge Economy — Leveraging
Strengths and opportunities”, states that India should make a transition (changeover) to the knowledge
economy.
 If Indian Economy uses its knowledge effectively (as used by Ireland), then its per capita income will
increase from a little over 1000 US Dollar in 2002 to 3000 US Dollar in 2020.
 The reports further states that the Indian Economy has all the key ingredients for making this transition. It
has large number of skilled workers, a well-functioning democracy and a diversified science and
technology infrastructure.

India as a knowledge Economy

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The Indian software industry has been showing an impressive record over the past decade.
 Entrepreneurs, bureaucrats and politicians are now advancing views about how India can transform itself
into a knowledge-based economy by using information technology (IT). Likewise, e-governance is being
projected as the way of the future.
 The value of IT depends greatly on the existing level of economic development. IT can make existing
assets and processes more effective and efficient. However, for this, basic infrastructure needs to be
developed.

IMPORTANCE OR ROLE OF HUMAN CAPITAL FORMATION

The importance/role of human capital formation will be clear from the following points:
1. Effective use of Physical Capital: The growth and productivity of physical capital depends extensively on
the human capital formation.
 The physical capital can be created only by means of hard and intelligent work of human beings in the
economy.
 Hence, human skill and their efforts help in effective utilization of physical capital.
2. Higher productivity and Production: Human capital formation raises the productivity and production as
knowledgeable and skilled worker makes better use of the resources.
 Increase in productivity and quality production depends on technical skill of the people, which can be
acquired only by means of education, training and maintaining the health of the people.
 Investment in human capital helps in acquiring new skills and also knowledge relating to management
of resources, technology and production.
3. Inventions, innovations and Technological improvement: The human capital formation stimulates
innovations and creates ability to absorb new technologies.
 Education provides knowledge to understand changes in society and scientific advancements, which
facilities inventions and innovations.
 Similarly, the availability of educated labour force facilitates adaptation to new technologies.
4. Modernization of attitudes: The knowledgeable, skilled and physically fir people are powerful instrument
of change in the society.
 Economical development of a country depends on the minds of the people and their changing attitudes
towards creating a “will’ for development.
 Investment in human capital helps in changing mental outlook and promotes development of the
economy.
5. Increases life expectancy: Formation of human capital raises life expectancy of the people. Health facilities
and availability of nutritive food enable people to love a healthy and long life. This in turn, adds to the
quality of life.
6. Improves Quality of Life: The quality of population depends upon the level of education, health of a
person and skill formation acquired by the people.
 Human capital formation not only makes people productive and creative, but also transforms the lives
of the people.
 People start living and enjoying higher incomes and more satisfying life.
7. Control of population growth: It has been observed that educated persons have smaller families as
compared to illiterate families. So, spread of education is necessary to control the population growth rate.
PROBLEMS OF HUMAN CAPITAL FORMATION
The various problems of human capital formation are;
1. Insufficient resources: The resources allocated to the formation of human capital have been much less
than the resources required. Due to this reason, the facilities for the formation of human capital have
remained grossly inadequate.
2. Serious inefficiencies: There is a lot of wastage of society’s resources as capabilities of educated people
are either not made use of (in case of unemployment) or are underutilized (in case of underemployment).

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 Massive illiteracy, non-education of many children, poor health facilities are other inefficiencies, which
have not been attended to adequately and properly.
3. Brain Drain: people migrate from one place to another in search of better job opportunities and handsome
salaries. It leads to the loss of quality people like doctors, engineers, etc. who have high caliber and are rare
in a developing country. The cost of such loss of quality human capital is very high.
4. High growth of Population: The continuous rise in population has adversely affected the quality of
human capital. It reduces per head availability of the facilities.
5. Several imbalances: A greater proprietor of resources have been diverted towards higher education, which
is meant for few people as compared to primary and secondary education. Due to this reason, general
productivity of the economy has remained low.
6. Lack of proper manpower planning: There is an imbalance between the demand and supply of human
resources of various categories, especially in case of highly skilled personnel. The absence of such
balancing has resulted in the wastage of resources.
7. Weak science and technology: In respect of education, the performance is particularly unsatisfactory in
the fields of science and development of modern technology.

HUMAN CAPITAL AND HUMAN DEVELOPMENT

The terms ‘Human Capital” and ‘Human Development’ sound similar, but there is a clear distinction between
them.
Human Capital Human Development
1. Human capital considers education and health 1. Human development is based on the idea that
as a means to increase labour productivity. education and health are integral to human wellbeing
since only when people have the ability to read and
apply their knowledge to derive maximum benefit
they will be able to lead a long and healthy life.

2. Human capital is a narrow concept which
treats human beings as a means to achieve an end
which is higher productivity, failing which the
investment is not considered to be productive.
2. Human development is a broader concept which
considers human beings as ends in themselves. Human
welfare can be achieved through investments in
education and health. It considers welfare — a right of
every individual irrespective of their contribution to
labour productivity. Every individual has right to be
literate and lead a healthy life.

HUMAN CAPITAL FORMATION IN INDIA: GREAT PROSPECTS

Human capital formation is the outcome of investments in education, health, on-the-job training, migration and
information. Out of all these elements, education and health are very important sources of human capital
information.
 We know that ours is a federal country with a union government, state governments and local governments
(Municipal Corporation, Municipalities and Village Panchayat). The constitution of India mentions the
functions to be carried out by all level of government.
 Accordingly, expenditures on both education and health are to be carried out simultaneously by all the three
tiers of the government.
 Education and health care services create with private and social benefits. As a result, both private and public
institutions exit in the education and health service markets.

Need for Government Intervention

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The expenditures on education and health assume great importance on the formation of human capital. So, it is
very important that such expenditure provides positive results. To ensure favourable benefits, Government
intervention is important because of following reasons;
1. The expenditures on education and health make substantial long-term impact and they cannot be easily
reversed. For example, if a child is admitted to a school or health care center and required services are
not provided in such institute, then substantial amount of damage would have been done before the
decision is taken to shift the child to another institution.
2. Individual consumers of these services do not have complete information about the quality of services
and their costs.
3. The providers of education and health services may acquire monopoly power and may get involved in
exploitation.
So, the role of government is to ensure that the private providers of these services adhere to be standards
stipulated by the government and charge the correct price.
Regulatory Authority
 In Education, The ministries of education at the union and state level and departments of education and
various organisations like National Council of Education Research and Training (NCERT), University
Grants Commission (UGC) and All India Council of Technical Education (AICTE) regulate the
education sector.
 In Health, The ministries of health at the union and state level, departments of health, and various
organisations like Indian Council for Medical Research (ICMR) regulate the health sector.
Basic Education and Health Care: Fundamental Right of every Citizen
 In a developing country like India, a large section of the population lives below poverty line and are
unable to afford basic education and health care facilities.
 Moreover, a substantial section of our people cannot afford to reach super specialty health care and
higher education.
 Furthermore, when basic education and health care is considered as a right of the citizens, then it is
essential that the government should provide education and health services free of cost for the deserving
citizens and those from the socially oppressed classes.
Both, the union and state governments have been raising expenditures in the education sector over the years in
order to fulfill the objectives of attaining 100 per cent literacy and health facilities for all.
EDUCATIONAL SECTOR IN INDIA
Growth in Government Expenditure on Education
The expenditure by the government on education is expressed in two ways:
1. As a percentage of total government expenditure: It indicates the importance of education in the
scheme of things before the government. During 1952 – 2014, it increased from 7.92 to 15.7.
2. As a percentage of Gross Domestic Product (GDP); It expresses the proportion of income spent on
development of education in the country. During 1952 – 2014, it increased from 0.64 to 4.13.
The increase in education expenditure has not been uniform and there has been irregular rise and fall.

Important Point about Government Expenditure

 Government spends more on Elementary Education: Elementary Education (primary and middle
school education) takes a major share of total education expenditure. Share of higher or tertiary
education (institutions of higher learning like colleges, polytechnics and universities) is the least.
 Expenditure on Tertiary Education is important: On an average, government spends less on tertiary
education. However, ’expenditure per student’ in tertiary education is higher than that of elementary
education. But, it does not mean that financial resources should be transferred from tertiary to
elementary education. As we expand school education, we need more teachers who are trained in the
higher educational institutions. So, expenditure on all levels of education should be increased.

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  Difference in Educational Opportunities across States; The per capita education expenditure differs
considerably across states from as high as ₨ 3,440 in Lakshadweep to as low as ₨ 386 in Bihar. This
leads to differences in educational opportunities and attainments across states.

Inadequate Expenditure on Education

The expenditure on education is very less as compared to the desired level of education expenditure
recommended by the various commissions. More than 40 years ago, the Education Commission (1964 – 66) had
recommended that at least 6 per cent of GDP should be spent on education. However, the current level
expenditure is little over 4 per cent which is quite inadequate.

Provision of Free and Compulsory Education

The Tapas Majumdar Committee, appointed by Indian Government in 1998, estimated an expenditure of around
Rs.1.37 lakh crore over10 years (1998-99 to 2006-07) to bring all children in the age group of 6 – 14 years
under the purview of school eduaction.
 In 2009, the Govt. of India enacted the Right of Education Act to make free education a fundamental
right of all children in the age group of 6-14 yeas.
 Govt. of India has also started levying 2% “education cess’ on all Union taxes. The revenue from
education cess has been embarked for spending on elementary education.
 In addition to this amount, the government sanctioned a large outlay for the promotion of higher
education and new loan schemes for students to pursue higher education.

EDUCATIONAL ACHIEVEMENTS IN INDIA

Educational Attainments in India
Particulars 1990 2000 2015
1.Adult Literacy Rate (per cent of people aged 15)
Male 61.9 68.4 81
Female 37.9 45.4 63

2. Primary Completion Rate (per cent of relevant age group)

Male 78 85 94
Female 61 69 99

Youth Literacy Rate (per cent of people aged 15 + to 24)

Male 76.6 79.7 92
Female 54.2 64.8 87

Adult Literacy Rate: Adult literacy rate refers to the ratio of literate adult population to the total adult
population in a country.
Primary Completion Rate: It is the percentage of students completing the last year of primary school.
Youth Literacy Rate: it is the percentage of people ages15 – 24 who can,, with understanding, read and write
a short, simple statement on their everyday life.

FUTURE PROSPECTS IN EDUCATIONAL SECTOR

Education for All: Still a Distant Dream
 The literacy rates for both adults as well youth have increased. However, the absolute number of
illiterates is still as much as India’s population was at the time of independence.

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  In 1950, it was noted in the Directives of the Constitution that the government should provide free and
compulsory education for all children up to the age of 14 years. Had we done this, we should have
achieved 100 % literacy by now.
Gender Equity: Better than Before
The differences in literacy rates between males and females are narrowing. It indicates a positive development
in gender equity. However, women education needs to be promoted:
 To improve economic independence and social status of women; and
 Women education makes a favourable impact on fertility rate and health care of women and children.
So, we cannot be satisfied about the upward movement in the literacy rates, until 100 per cent literacy rates is
achieved.
Higher Education: a Few Takes
 The Indian education pyramid is steep indicating lesser and lesser number of people reaching the higher
education level.
 As per NSSO data, in 2011-12 the unemployment rate of unemployment among youth males who
studied graduation and above in rural areas was 19%. Their urban counterparts has relatively less level
of unemployment at 16%. The most severly affected ones were young rural females graduates as nearly
30% of them are unemployed. In contrast to this, only 3-6% of primary level educated youth in rural
and urban areas were unemployed. .
Therefore, the government needs to increase allocation for higher education and also improve the standard of
higher education institutions, so that students are imparted employable skills in such institutions.
Conclusion
Economic and social benefits of human capital formation and human development are well known. The union
and state governments have been allocating substantial amount for development of education and health sectors.
The spread of education and health services across different sectors of society should be ensured so as to
simultaneously attain economic growth and equity. India has a rich stock of scientific and technical manpower
in the world. We need to improve it qualitatively and provide such conditions so that they are utilised in our
own country.

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