(MS.

SONIA KHOSLA)
Ch.5 Human capital Formation (HCF)
There are two forms of capital formation:
1. Physical capital
2. Human capital
➢ Physical capital: All the inputs which are required for the
production of goods and services such as machines, tools
and equipment, raw material etc. are termed as physical
capital.
➢ Human capital: It is the stock of knowledge, skills and
enterprise embodied in the people of a nation at a given
point of time.
Differences between physical and human capital:
The following table shows the two forms of capital formation are
different from each other.

Basis Physical Capital Human Capital

1.Meaning All the inputs which are
required for the
production of goods and
services such as machines,
tools and equipment, raw
material etc. are termed
as physical capital.
It is the stock of
knowledge, skills and
enterprise embodied
in the people of a
nation at a given
point of time.

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2. Nature Physical capital for eg. Human capital is
machine is tangible and intangible and is not
can be easily sold in the sold in the market
market like any other only the services of
commodity. human capital are
sold
3.Owner Physical capital is Human capital is not
separable from its owner. separable from its
owner.
4. Financial Physical capital can be Human capital
statement shown in financial cannot be shown in
statements. the financial
statements.
5. Nature of Continuous use of physical Depreciation takes
depreciation capital leads to place with the age
depreciation. but can be reduced
to a large extent of
continuous
investment in
education, health etc.
6. No restriction except Occurs out of
Restriction under trade barriers. nationality and
on mobility culture.
7. Nature of Physical capital creates Human capital
benefit only private benefit i.e benefits not only the
benefits from a capital owner but also the
good flow to those who society in general.
paid the price for the
product and services
produced by it.

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Meaning of Human Capital Formation (HCF)
Human capital formation means increasing the People’s level of
productivity and efficiency by making them more educated and
healthy.
Sources of HCF or Factors contributing to HCF:
➢ Education
➢ Health
➢ Training
➢ Migration
➢ Acquiring information relating to labour and other market
1. Education:
• It prepares people for the ever- changing situation by
developing appropriate values, aptitude, knowledge and skills.
• It provides capacity and flexibility to the people and enable
them to contribute to the economic development of the
country.
• Education increases the level of understanding of the people
and technical education helps in increasing their efficiency and
productivity.
• Improving the productive capacity of a nation’s workforce by
increasing their skill.
• Spending on education by individuals is similar to spending on
capital goods by companies with the objective of increasing
future profits over a period of time.

Likewise, individuals invest in education with the objective of

increasing their future income.
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2.Health:
• The wealth of a country can be increased with the efforts of
healthy workforce. Investment in health sector increases
efficiency and productivity of a nation’s work force.
• Health expenditure directly increases the supply of healthy
labour force and thus, is a source of human capital formation.
This includes healthcare services like hospitals, medicines etc.
and also health education to maintain good health.
• A healthy person contributes in the development of a country
by increasing the efficiency and productivity. It will result in a
better quality of life.
• Various forms of health expenditure are:
a) Preventive medicine (vaccination)
b) Curated medicine (medical intervention during illness)
c) Social medicine (spread of health literacy)
d) Provision of clean drinking water and good sanitation

Health expenditure directly increase the supply of healthy

labour force and thus it is a source of human capital formation.
3.Training:
• Training refers to the act of acquiring skills, knowledge and
competency required to perform a particular job efficiently and
effectively.
• Technical training adds to the capacity of the people to
produce more.

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 • It can be of two types:
(a) The workers may be trained in the firm itself under the
supervision of a skilled worker (i.e. on the job training)
(b)The workers may be sent for off campus training.
• Expenditure regarding, on the job training is a source of human
capital formation. As the return of such expenditure, in the
form of enhanced labour productivity is more than the cost of
it.
In both these cases firms incur some expenses. Hence, the firms will
insist that the workers should work for a minimum specific period of
time after their on the job training.
4. Migration:
• It refers to the movement of persons from one place or
country to another especially in order to find work or to live.
• The main cause for rural urban migration in India is
unemployment. Migration involves cost of transport, higher
cost of living in the migrated places.
• The enhanced earnings in the new place overcome the cost of
migration hence expenditure on migration is also a source of
human capital formation.
5. Acquiring information relating to labour and other market:
• The availability of jobs and admission related information not
only help the students to opt for the best choice according to
their interest areas but also lead to the effective utilisation of
human skills and knowledge.

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 • This expenditure (for acquiring information) is also a source of
human capital formation because this information is necessary
to make decisions regarding investment in human capital as
well as for efficient utilisation of the acquired human capital
stock.
• People seek information regarding salaries and other facilities
available in the different labour market so that they can
choose the right job.
• Similarly, people will like to know about education institution,
their educational standards, cost of education, whether they
provide right type of education, skill and at what cost.
Expenditure on acquiring all sorts of information regarding labour
market and other market is also an important source of human
capital formation.
Difference between human capital and human development:
Human Capital Human Development
1. It refers to the stock of a 1. It refers to the process of
nation’s human skills and creating an environment in
expertise at a particular point which people can enjoy long,
of time. Human capital treats healthy and creative lives by
humans as just another giving them opportunity to
resource like machine, grow.
technology etc.
2. Human capital treats 2. In the human development
human beings as a means to perspective, human beings
increase productivity hence are ends in themselves.
the end being the increase in Human welfare should be
productivity. increased through investment
in education and health.
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3. Investment in education
and health is unproductive if
it does not lead to rise in
production of goods and
services.
3. Investment in education
and health is productive, even
if it does not lead to rise in
production of goods and
services, as every individual
has a right to be literate and
lead a healthy life. Basic
health and basic education
are important in themselves.

Importance of human capital formation in economic development:

1.Increases efficiency and productivity:
• Human capital formation raises the productivity and
production as skilled and efficient workers make better use of
given resources.
• Technical skill can be acquired only by means of education,
training and sound health of the people.
• Investment in human capital produces such skills and expertise
which increase their productivity which is essential for
economic growth.
2. Improves quality of life:
• The quality of life improves due to quality education, health
and skill formation acquired by the people.
• Human capital formation enables them to enjoy a higher
standard of living as they are able to generate better
remuneration for them and for the nation.

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3. Positive change in attitude:
• Investment in human capital makes people more
knowledgeable, skilled and modern in their thoughts and
actions.
• It increases their outlook and attitude towards various aspects
such as traditions, job markets, mobility etc. which are helpful
in the development of the country.
• They are able to make rational choices in respect of job
opportunities.
• It leads to emergence of modern society desired for economic
development.
4. Innovations and technological improvement:
• Technological upgradation is important for structural changes.
The human capital formation 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 hence facilitate
inventions and innovations.
• The availability of educated labour force facilitates adaption to
new technologies. Thus, human capital formation promotes
innovations and discoveries to develop the economy.

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Problems of human capital formation in India:
1.High growth rate of population:
• Continuous rise in population has adversely affected the quality
of human capital. It has reduced per capita availability of
benefits of economic growth relating to houses, hospitals,
education etc. have reduced due to rising population.
• Rapidly rising population lowers the capacity to possess skill
and expertise required for economic growth.
2. Migration:
• Loss of resources in terms of ‘Brain Drain’ is a serious outcome
of migration. When educated and skilled manpower moves to
the other countries to work.
• The country like India cannot afford migration of persons of
high calibre and possessing high quality education who choose
to render their services abroad.
3. Lack of proper manpower planning:
• In India, there exist imbalance between the demand for and
supply of human resources required for different categories of
work.
• In India, there is poor manpower planning which corresponds
to wastage of scarce resources of the nation.
• We require a proper system of manpower planning so that
there may be equilibrium determined between demand and
supply of human resources.

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4. Low level of academic standards:
• Educational facilities in India have not developed as required
for economic growth.
• There is mismatch between the requirements of skills and
available academic standards. The result of this is that skills,
training and expertise obtained by human capital is insufficient
to meet the desired standards of economic growth.
5. Inefficient system:
There are widespread inefficiencies in:
• Arranging on the job and off the job training programs for
human capital.
• Utilising scares resources efficiently because of lack of human
resource development.
• Providing proper healthcare facilities.
• Eradicating widespread poverty, illiteracy and unemployment.
6.Poverty:
• There is widespread poverty in India creating lack of finances
and awareness a major problem facing human capital
formation.
• A large proportion of population do not have access to basic
health and educational facilities. Due to their inability to get
higher education and maintaining a reasonable standard of
health, they are not able to develop themselves as sound
human capital.

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Relationship between human capital and economic growth
Economic growth means the increase in real national income of a
country. Investment in human capital contribute to economic
growth because
• The contribution of the educated person to the economic
growth is more than that of an illiterate person.
• Healthy Person can provide an uninterrupted labour supply for
a longer period of time, so health is also an important factor for
economic growth.
• Similarly, on the job training, job market information and
migration, increase an individual’s income generating capacity.
This enhanced productivity of human beings or human capital
contribute substantially not only towards increasing labour
productivity 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.
Higher income causes building of high level of human capital
and high level of human capital causes growth of income.
Important note1: It is difficult to establish a relation of cause
and effect from the growth of human capital (education and
health) to economic growth but we can see in the table given
below that these sectors have grown simultaneously. Growth
in each sector probably has reinforced the growth of every
other sector.

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TABLE:

Note 2: Empirical evidence prove that increase in human

capital causes economic growth is not clear because of
measurement problems. 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.
Using the indicators mentioned above, an analysis of
improvement in education and health sector and growth in real
per capita income in both developing and developed countries
shows that the human capital growth in developing countries
has been faster but the growth of per capita real income has
not been that fast.
Note 3: India recognised the importance of human capital in
economic growth long ago. The seventh five-year plan says,
“Human resources development (human capital) has
necessarily to be assigned a key role in any development
strategy particularly in a country with a large population.
Trained and educated population can itself become an asset
in accelerating economic growth and ensuring social change in
desired directions.”
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Two independent reports (one by Dutch bank and other by World
bank) on Indian economy, in recent times, have identified that India
would grow faster due to its strength in human capital formation.
Dutch bank report:
• It is a German Bank. It published a report titled Global Growth
Centers on 01/7/2005.
• This report identified India as one of the major growth centers
by 2020.
• Human Capital is the most important factor that determines
economic growth. Increase in human capital leads to increase
in GDP.
• Between 2005 and 2020, there will be 40% rise in the average
years of education in India.
World bank report: India must develop in to a Knowledge
Economy
• The knowledge economy is the use of knowledge to create
goods and services. It refers to development of skilled and
educated manpower in order to take the country to progress.
Best Example is Japan
• World Bank published a report titled, India and the knowledge
economy – showing Strengths and Weaknesses.
• It states that India should make a change to the knowledge
economy.

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 • If India uses its knowledge like Ireland, then the per capita will
increase from US$ 1000 (2002) to US $ 3000(2020).
• India has everything needed for this change. There are large
number of skilled workers, a well functioning democracy and a
diversified science and technology infrastructure.
• IT sector is well developed in India.
• E Governance is already introduced.
Need for government intervention in education and health sector
India is a federal country having three tires of government i.e.
➢ Union government
➢ State government
➢ Local government (including Municipal Corporations,
Municipalities and Village Panchayats)
The expenditures on both education and health are to be
carried out simultaneously by all of them. Since education and
healthcare services create both private and social benefits
therefore there exist both private and public institutions in
education and health service markets.

(a) Expenditure on education make substantial long-term

impact and they cannot be easily reversed hence government
intervention is essential.
For example, once a child is admitted to a school or health care
centre where the required services are not provided, a
substantial amount of damage would have been done till the
decision is taken to shift the child to another institution.
Moreover the consumers of these services don’t have
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 complete information about the quality of services and their
cost. In this situation the providers of education and health
services require monopoly power and are involved in
exploitation.
The role of government is to ensure that the private providers
of these services adhere to the standard stipulated by the
government and charge the correct price.
(b)In developing country like India most of the population living
below poverty line cannot afford to access basic education and
health care facilities. It is essential that the government should
provide education and health services free of cost for the
deserving citizens as the basic education and health is the right
of all the citizens.
(c)Both Union and State Government have been encouraging
expenditure in education sector over the years to fulfil the
objective of attaining 100% literacy.
Institutions which come under the education sector are facilitated
by :
➢ The Ministries of Education at the union and state level
➢ Departments of Education
➢ Various organisations like National Council of Educational
Research And Training (NCERT) and University Grant
Commission (UGC), All India Council of Technical Education
Institution (AICTE)
Institutions which come under the health sector are facilitated by:
➢ Ministries of health at union and state level
➢ Department of health
➢ Organisations like Indian Council for Medical Research (ICMR)
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Growth in government expenditure on education in India
Government expenditure on education is expressed in two ways:
(a)As a percentage of total government expenditure:
It indicates importance given to education in various government
schemes.
(b)As a percentage of GDP:
It shows how much of our income is being committed for the
education development in the country.
Following steps taken by government have led to growth of
education sector in India:
(1) During 1952 to 2014, on the basis of criteria (a) mentioned
above, the expenditure has increased from 7.92% to 15.7 %
On the basis of criteria (b), it has increased from 0.64 % to 4.13 %.
In 2009, the Government of India enacted right to education act
(RTE) to make free education a fundamental right of all the citizen in
the age group of 6 to 14 years.
Government of India has started levying a 2% education cess on all
union taxes. The revenue from education cess has been embarked
for spending on elementary education.
Government sanctions a large expenditure for the promotion of
Higher Education and new loan schemes for the students to pursue
higher education.

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Analysis of the above table:
1.Adult literacy level: This rate indicates the percentage of the
literate adult population who are aged 15 years and above.
This ratio has increased.
• Male literacy : 61.9% in 1990 to 81% in 2015
• Female Literacy: 37.9% in 1990 to 63% in 2015
2.Primary education completion rate: This rate indicates the
percentage of students completing classes 1 to 8.
This ratio has increased
• Males – 78% in 1990 to 94% in 2015
• Females: 61% in 1990 to 99% in 2015
3.Youth literacy rate: This rate indicates the percentage of literate
people between the age of 15 to 24, who can read and write.
This ratio has increased
• Males – 76.6% in 1990 to 92% in 2015
• Females- 54.2 % in 1990 to 87% in 2015.

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Expenditure on different level of education in India
• Largest part of Government expenditure is on Primary
Education.
• Expenditure per student is highest in tertiary education (Higher
Education).
• Inter- State variations in per capita-expenditure on elementary
education
➢ Rs. 34651 in Himachal Pradesh
➢ Rs. 4088 in Bihar
Expenditure on Education is insufficient in India
• The Education Commission recommended that at least 6% of
the GDP should be spent on education. Our expenditure is less
than 4%.
• Tapas Majumdar Committee recommended that the
Government should spend at least 1.37lakh crore during a
period of 10 years (1998 -99 to 2006 – 07) to provide education
to all the children below 14 years. We failed to spend that
much amount of money.

IMPORTANCE OF WOMEN’S EDUCATION IN INDIA

• Women constitute nearly 50% of the population. They are
valuable human resources. Educating them will help in the
economic development of our country.
• Education will contribute to women empowerment and
achieving the goal of gender equality.
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• It will help in better care for children and reduction in infant
mortality rate.
• It will reduce child marriages and promote small family norm.
Population growth rate will be controlled.
• Women will become economically independent.
• It will reduce domestic violence and dowry harassment.
• Women constitute nearly 50% of the population. They are
valuable human resources. Educating them will help in the
economic development of our country.
• Education will contribute to women empowerment and
achieving the goal of gender equality.
• It will help in better care for children and reduction in infant
mortality rate.
• It will reduce child marriages and promote small family norm.
Population growth rate will be controlled.
• Women will become economically independent.
• It will reduce domestic violence and dowry harassment.
IMPORTANT ELEMENTS OF FUTURE EDUCATIONAL POLICY IN
INDIA
• Education for All: Free and compulsory education for all
children below 14 years of age is one of the Directive Principles
of State Policy. In 2019, Right to education Act was passed to
achieve this goal. Sarvashiksha Abhyan is launched (Operation
Black Board) and Mid – day meal is provided. Still, this goal is
not achieved.
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• Gender Equality: traditionally. Education of women is
neglected in India. Literacy rate among women is less than that
of men. In higher education also, women’s representation is
very less. Recently, this gap has been reducing. Still, we need to
work towards this goal.
• Higher Education: Very less number of people go for higher
education in India. The fees is very high and not affordable to
the poor people. The Government has to make investment and
make Higher education affordable for all.

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