CHAPTER 5 : HUMAN CAPITAL FORMATION

Physical resources: eg land

Physical capital: eg factories

Human resources: eg students, nurses, farmers, teachers

Human capital: engineers and doctors.

A country needs sufficient human capital in the form of competent people to

produce other human capital (farmers, teachers, doctors, engineers). This means
investment in human capital is needed to produce more human capital from
human resources.

HUMAN CAPITAL

It refers to the stock of skills and expertise of a nation at a given point of time.

SOURCES OF HUMAN CAPITAL

1. Investment in education:

➔ Why is investment in education important?

● Investment in education accelerates the development process as the labour
skill of an educated person is more than that of an uneducated person and so an
educated person is able to generate more income than an uneducated person
and his contribution to economic growth is more.
● individuals invest in education with the objective of increasing their future income.

● it gives a better social standing and pride

● it enables one to make better choices in life

● it provides knowledge to understand the changes taking place in society

● It also stimulates innovations.

● The availability of an educated labour force facilitates adaptation of new

technologies.

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Hence, investment in education is considered as one of the main sources of human
capital.

2. Health:

● Expenditure on health is an important source of human capital formation

since Health expenditure directly increases the supply of a healthy labour
force.

● A sick labourer without access to medical facilities is compelled to abstain

from work and there is loss of productivity. Therefore, a healthy person
can contribute much more to the national income

Expenditure on health can be made under the following categories:

A. Preventive medicine (vaccination)

B. Curative medicine (medical intervention during illness)

C. Social medicine (spread of health literacy)

D. Provision of clean drinking water and good sanitation

3. On the job training:

● Firms spend on giving on the job-training to their workers. This may take different
forms:

i) the workers may be trained in the firm itself under the supervision of a skilled
worker

ii) the workers may be sent for off-campus training.

● In both these cases firms incur some expenses. So, firms insist that the workers
should work for a specific period of time, after their on-the-job training, so that the
firms can get the benefits of the enhanced productivity owing to the 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.

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4. Migration:

● People migrate in search of jobs that fetch them higher salaries than what they
may get in their native places.

● Unemployment is the reason for the rural-urban migration in India.

● Technically qualified persons, like engineers and doctors, migrate to other

countries because of higher salaries that they may get in such countries.

● Migration in both these cases involves 3 types of costs:

➢ cost of transport

➢ higher cost of living in the migrated places

➢ psychic costs of living in a strange socio-cultural setup.

● The enhanced earnings in the new place outweigh the costs of migration

● Hence, expenditure on migration is also a source of human capital formation.

5. Expenditure on information

● People spend money on information related to the labour market and other
markets like education and health.

● 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.

● This information is necessary to make decisions regarding investments in human

capital and for efficient utilisation of the acquired human capital stock.

The concept of physical capital is the base for conceptualising human capital.

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Relationship between Human Capital and Economic Growth:

1. Economic growth means the increase in real national income of a country.

2. The contribution of the educated person to economic growth is more than that of
an illiterate person since the labour skill of an educated person is more.Hence a
software professional generates more income than a worker in a factory.
3. A healthy person is able to provide uninterrupted labour supply for a long period
of time, hence health is an important factor for economic growth.
4. Human capital increases labour productivity and stimulates innovations and
creates the ability to absorb new technologies.
5. Thus, education, health, and other factors like on-the-job training, job market
information and migration, increase an individual’s income generating capacity.

Q. Causality between human capital and economic growth flows in either

direction. Comment.

- High economic growth —> higher income —-> high level of human capital —-->
economic growth.

However, Empirical evidence to prove that increase in human capital causes

economic growth is rather nebulous (unclear). This may be because of:

1. Measurement problems: For example:

- education which is measured in terms of years of schooling, teacher -pupil
ratio and enrolment rates may not reflect the quality of education

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 - Health services measured in monetary terms, life expectancy and
mortality rates may not reflect the true health status of the people in a
country.
2. An analysis of improvement in education and health sectors 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.

- Hence, It is difficult to establish a relation of cause and effect from the growth of
human capital (education and health) to economic growth but Growth in each
sector reinforces the growth of every other sector.

India recognised the importance of human capital in the Seventh Five Year Plan which
said:

➢ Human capital has 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 in ensuring social change in desired directions

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The National Education Policy 2020

● states that the world is undergoing rapid changes in knowledge.

● With various scientific and technological advances in machine learning and
artificial intelligence, many unskilled jobs may be taken over by machines
● With climate change, increasing pollution, and depleting natural resources, and
the growing emergence of epidemics and pandemics, will increase the need for
multidisciplinary learning.
● There will be a growing demand for humanities and art, as India moves towards
becoming a developed country to be among the three largest economies in the
world.

HUMAN CAPITAL AND HUMAN DEVELOPMENT (Differences)

HUMAN CAPITAL HUMAN DEVELOPMENT

It considers education and health as a It is based on the idea that education and
means to increase labour productivity. health are integral to human well-being as it
enables one to make better choices.

It treats human beings as a means to an It treats human beings as ends in themselves.

end; the end being the increase in
productivity.

Any investment in education and health is Human welfare should be increased through
unproductive if it does not enhance output investments in education and health even if
of goods and services. such investments do not result in higher labour
productivity.

It is a narrow concept It is a broad concept

According to human development perspective, every individual has a right to be literate

and lead a healthy life irrespective of their contribution to labour productivity.

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STATE OF HUMAN CAPITAL FORMATION IN INDIA

1. India is a federal country with a union government, state governments and local
governments (Municipal Corporations, Municipalities and Village Panchayats).
The Constitution of India mentions the functions of each level of government.
2. Accordingly, expenditures on both education and health are to be carried
out simultaneously by all the three tiers of the government.
3. India as a Knowledge Economy:
● The Indian software industry has been showing an impressive record over the
past two decades.
● Entrepreneurs, bureaucrats and politicians are now advancing views about how
India can transform itself into a knowledge-based economy by using information
technology (IT).
● Villagers using e-mail is an example of such transformation. Also e- governance
is being projected as the way of the future.

THE NEED FOR GOVERNMENT INTERVENTION IN EDUCATION AND HEALTH

SECTORS.

▪ Education and health care services create both private and social benefits
and this is the reason for the existence of both private and public institutions in
the education and health service markets.

▪ Expenditures on education and health make substantial long-term impact and

they cannot be easily reversed; hence, government intervention is essential.
For instance, once a child is admitted to a school or health care centre where the
required services are not provided, before the decision is taken to shift the child
to another institution, substantial amounts of damage would have been done.

▪ Individual consumers of these services do not have complete information

about the quality of services and their costs. In this situation, the private
providers of education and health services acquire monopoly power and are
involved in exploitation. The government’s role in this situation is to ensure that
the private providers of these services charge the correct price.

▪ Basic education and health care is considered as a right of the citizens. A

substantial section of our poor population cannot afford to reach super specialty
health care and higher education. It is therefore essential that the government
should provide education and health services free of cost to them.

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AGENCIES REGULATING EDUCATION AGENCIES REGULATING HEALTH
SECTOR IN INDIA: SECTOR IN INDIA:

1.The ministries of education at the union and 1.the ministries of health at the union and
state level state level

2. Departments of education and various 2. Departments of health and various

organisations like: organisations like:

National Council of Educational Research and Indian Council for Medical Research (ICMR)
Training (NCERT),
National Medical Commission
University Grants Commission (UGC)

All India Council of Technical Education (AICTE)

GROWTH IN GOVERNMENT EXPENDITURE ON EDUCATION

This expenditure by the government is expressed in two ways:

(i) As a percentage of ‘total government expenditure’. It indicates the

importance of education for the government.

(ii) As a percentage of Gross Domestic Product (GDP). It expresses how

much of people’s income is being committed to the development of education
in the country.

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EDUCATION SECTOR IN INDIA:

1. During 1952-2014, education expenditure as percentage of total government

expenditure and as percentage of GDP increased. But, the increase has not
been uniform. To this if the private expenditure incurred by individuals and by
philanthropic institutions is added, the total education expenditure is much higher.
2. Elementary education takes a major share of total education expenditure and the
share of the higher/tertiary education (institutions of higher learning like colleges,
polytechnics and universities) is the least.
3. Though, on an average, the government spends less on tertiary education,
‘expenditure per student’ in tertiary education is higher than that of elementary.
4. As we expand school education, we need more teachers who are trained in the
higher educational institutions; therefore, expenditure by the government on all
levels of education should be increased.
5. In 2014-15, the per capita public expenditure on elementary education differs
across states with Himachal Pradesh having a high expenditure to Bihar very
low. This implies differences in educational opportunities across states.
6. The Education Commission (1964–66) had recommended that at least 6 per cent
of GDP be spent but at present only 4 per cent is spent.
7. The Tapas Majumdar Committee, appointed by the Government of India in 1999,
aimed to bring all Indian children in the age group of 6-14 years under the
purview of school education.
8. In 2009, the Government of India enacted the Right of Children to Free and
Compulsory Education Act to make free education a fundamental right of all
children in the age group of 6-14 years.
9. The Government of India has also started levying a 2 per cent ‘education cess’
on all Union taxes. The revenues from education cess has been earmarked for
spending on elementary education.
10. The government sanctions a large expenditure for the promotion of higher
education and new loan schemes for students to pursue higher education.

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EDUCATIONAL ATTAINMENTS IN INDIA

Educational achievements in a country are indicated in terms of: adult literacy level,
primary education completion rate and youth literacy rate. The statistics for the last two
decades have shown an increase. They are as follows:

Particulars 1990 2000 2017-

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1. Adult Literacy Rate (% of people aged 15+) Males 61.9 68.4 82

Females 37.9 45.4 66

2. Primary Completion Rate (% of relevant age Males 78 85 93

group)

Females 61 69 96

3. Youth Literacy Rate (% of people aged 15+ to Males 76.6 79.7 93

24)

Females 54.2 64.8 90

FUTURE PROSPECTS:

EDUCATION FOR ALL — STILL A DISTANT DREAM:

● In 1950, when the Constitution of India was passed by the Constituent Assembly,
it was noted in the Directive Principles of the Constitution that the government
should provide free and compulsory education for all children up to the age of 14
years within 10 years from the commencement of the Constitution
● Though literacy rates for both adults as well as youth have increased, yet
attainment of 100% percent literacy is not reached.
● The absolute number of illiterates in India is as much as India’s population was at
the time of independence

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 GENDER EQUITY — A POSITIVE DEVELOPEMENT:

● The differences in literacy rates between males and females are narrowing
indicating a positive development in gender equity.
● But there is still a need to promote education for women in India for various
reasons such as:
- Improving social status of women
- Promoting economic independence and
- Making a favourable impact on fertility rate and health care of women and
children.

HIGHER EDUCATION — LIMITED REACH:

● The Indian education pyramid is steep, indicating a lesser and lesser number of
people reaching the higher education level.

● The level of unemployment among educated youth is the highest.

● To ensure that students are given employable skills, the government should

⮚ Increase allocation for higher education

⮚ Improve the standard of higher education institutions

Level of Unemployment Among Educated Youth (2011-12)

Gender Region Education Level % Unemployment

Rate

Male Rural Graduation and 19

above

Urban Graduation and 16

above

Female Rural Graduation and 30

above

Rural and urban Primary level 3-6%

Source – NSSO

● The situation is yet to improve as indicated by the Periodic Labour Force Survey
2017-18.

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Human capital and physical capital - Both the forms of capital are outcomes of conscious
investment decisions.

- Decision regarding investment in physical capital is taken on the basis of one’s

knowledge for eg. An entrepreneur uses his knowledge to calculate the expected
rate of return of investment and then decide if the investments should be made.
- The ownership of physical capital is the outcome of the conscious decision of the
owner — the physical capital formation is mainly an economic and technical
process.

♦ Whereas, human capital formation takes place in one’s life when he is unable to
decide whether it would maximise his earnings.

♦ Children are given different types of school education and health care facilities by
their parents and the society.

♦ The peers, educators and society influence the decisions regarding human
capital investments even at the tertiary level, that is, at the college level.

♦ Moreover, the human capital formation at this stage is dependent upon the
already formed human capital at the school level.

♦ Human capital formation is partly a social process and partly a conscious

decision of the possessor of the human capital.

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 Differences:
Basis of difference Physical capital
Definition All inputs which are required Stock of skill, knowledge and enterprise
for further production such as embodied in the people, e.g. engineers
machines, tools and
implements, factory
buildings, etc.
Separation from It is tangible (separable from
Owner its owner) and can be easily
sold in the market like any
other commodity e.g. in case
of a physical product - bus,
the owner need not be
present in its place of use.
Mobility It is completely mobile
between countries except for
some artificial trade
restrictions. It can be built
through imports.
Nature of It depreciates with
depreciation continuous use and change
in technology.
Human capital
and doctors.
It is intangible (not separable but
endogenously built in the body and mind
of its owner), and not sold in the market
e.g. a bus driver who possesses the
knowledge and ability to drive the bus,
should be present when the bus is used
for transportation service.
It is not perfectly mobile between
countries and is restricted by nationality
and culture. It cannot be imported but has
to be built through conscious policy
formulations and expenditure by the
state.
It depreciates due to ageing. However it
may be reduced to a large extent,
through continuous investment in
education, health etc. which enables it to
cope with change in technology.
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Nature of benefits It creates only private
benefits i.e. only for the
owner e.g. only those who
pay the price for the product
and services produced are
able to enjoy the benefits.
It creates both private and social benefits
i.e. for the owner as well as the society in
general e.g. A healthy individual, by
maintaining personal hygiene and
sanitation, stops the spread of contagious
diseases and epidemics.
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.

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