Human Capital Theory: Implications for Educational Development

Leroy Almendarez


Education is an engine of growth and key to development in every society, based on its quality and quantity. In order to make a significant contribution to economic growth and development, high quality education is required. The twenty-first century paradigm is shifting towards the enhancement of knowledge as a priority. This has likely been a product of the resonation of states connecting their higher educational systems much more closely to their various economic development strategies.

Education is an economic good because it is not easily obtainable and thus needs to be apportioned. Economists regard education as both a consumer and capital good, because it offers utility (satisfaction) to a consumer and also serves as an input to develop the human resources necessary for economic and social transformation. The focus on education as a capital good related to the concept of human capital, which emphasizes that the development of skills is an important factor in production activities. It is widely accepted that education creates improved citizens and helps to upgrade the general standard of living in a society. The increased faith in education as an agent of change in many developing countries, has led to heavy investments in it. The pressure for higher education in many developing countries has undoubtedly been helped by public perception of financial reward from pursuing such education. There is belief that expanding educational opportunities and access promotes economic growth.

The economic prosperity and functioning of a nation depend on its physical and human capital stock. Physical capital has traditionally been the focus of economic research, factors affecting the enhancement of human skills and talent are increasingly figured in the research of social and behavioural sciences. In general terms, human capital represents the investment people make in themselves that enhance their economic productivity. The theoretical framework most responsible for the wholesome adoption of education and development policies has come to be known as human capital theory.

Human Capital Theory

Human capital theory rests on the assumption that formal education is highly is highly instrumental and necessary to improve the productive capacity of a population. In short, human capital theorists argue that an educated population is a productive population. Human capital theory emphasizes how education increases the productivity and efficiency of workers by increasing the level of cognitive stock of economically productive human capability, which is a product of innate abilities and investment in human beings. The provision of formal education is seen as an investment in human capital, which proponents of the theory have considered as equally or even more worthwhile than that of physical capital (Woodhall, 1997).

Human Capital Theory (HCT) concludes that investment in human capital will lead to greater economic outputs however the validity of the theory is sometimes hard to prove and contradictory. �In the past, economic strength was largely dependent on tangible physical assets such as land, factories and equipment.� Labor was a necessary component, but increases in the value of the business came from investment in capital equipment. �Modern economists seem to concur that education and health care are the key to improving human capital and ultimately increasing the economic outputs of the nation (Becker 1993).

In the new global economy, hard tangible assets may not be as important as investing in human capital.�� Thomas Friedman, in his wildly successful book, The World is Flat 2007, wrote extensively about the importance of education in the new global knowledge economy.�� Friedman, not to be confused with the famous economist Milton Friedman, is a journalist. His popular book has exposed millions of people to human capital theory.� The term itself is not introduced, but evidence as to why people and education (human capital) are vital to a nation’s economic success, is a common reoccurring theme in the book.

Throughout western countries, education has recently been re-theorized under human capital theory as primarily an economic device. Human capital theory is the most influential economic theory of western education, setting the framework of government policies since the early 1960s. It is increasingly seen as a key determinant of economic performance. A key strategy in determining economic performance has been to employ a conception of individuals as human capital and various economic metaphors such as �technological change�, �research�, �innovation�, �productivity�, �education�, and �competiveness�. Economic consideration per se in the past, however, has not determined education.

Noted economist, Adam Smith, in the The Wealth of Nations (1976) formulated the basis of what was later to become the science of human capital. Over the next two centuries, two schools of thought were distinguished. The first school of thought distinguished between acquired capacities that were classified as capital and human beings themselves, who were not. The second school of thought claimed that human beings themselves were capital. In modern human capital theory all human behaviour is based on the economic self-interest of individuals operating within freely competitive markets.

Human capital theory stresses the significance of education and training as the key to participation in the new global economy. In one if it�s the recent reports, the Organization of Economic Cooperation and Development (OECD), for example, claims that the radical changes to the public and private sectors of the economy introduced over recent years in response to globalization will be severe and disturbing to many established values and procedures. In another report it explains internationalism in higher education as a component of globalization. The OECD believes that internationalism should be seen as an imperative in 21st Century capitalism. This form of capitalism is based on investment in financial markets rather than in manufacturing of commodities, thus requiring dependence on electronic technology.

The OECD also boldly asserts that internationalism is a means to improve the quality of education. In keeping with human capital theory, it has been argued that the overall economic performance of the OECD countries is increasingly more directly based upon their knowledge stock and their learning capabilities. Clearly, the OECD is attempting to produce a new role for education in terms of human capital subject required in globalized institutions.

The success of any nation in terms of human development is largely dependent upon the physical and human capital stock. Thus, recent social research focuses on the behavioral sciences of humanity in relation to economic productivity. Generally, human capital represents the assets each individual develops to enhance economic productivity. Further, human capital is concerned with the wholesome adoption of the policies of education and development. In short, the human capital theorists argue that an educated population is a productive population. Human capital theory emphasizes how education increases the productivity and efficiency of workers by increasing the level of cognitive stock of economically productive human capability, which is a product of innate abilities and investment in human beings. The provision of formal education is seen as a productive investment in human capital, which the proponents of the theory have considered as equally or even more equally worthwhile than that of physical capital.

According to Babalola (2003), the rationality behind investment in human capital is based on three arguments:

  1. The new generation must be given the appropriate parts of the knowledge which has already been accumulated by previous generations.
  2. The new generation should be taught how existing knowledge should be used to develop new products, to introduce new processes and production methods and social services;
  3. People must be encouraged to develop entirely new ideas, products, processes, and methods through creative approaches.

Fagerlind and Saha (1997) posit that human capital theory provides a basic justification for large public expenditure on education both in developing and developed nations. The theory is consistent with the ideologies of democracy and liberal progression found in most western societies. Its appeal was based upon the presumed economic return of investment in education at both the macro and micro levels. Efforts to promote investment in human capital were seen to result in rapid economic growth for society. For individuals, such investment was seen to provide returns in the form of individual economic success and achievement. Most economists agree that it is human resources of nation, not its capital nor its material resources, which ultimately determine the character and pace of its economic and social development. Human resources constitute the ultimate basis of the wealth of nations. Capital and natural resources are passive factors of production, human beings are the active agencies who accumulate capital, exploit natural resources, build social, economic, and political organizations, and carry forward national development.

Empirical Evidence of Human Capital Model

Based on the significance of education, the concept of human capital has been brought to the forefront of many discourses in the field of economic growth and development. Studies have shown that improvements in education accelerate productivity and contribute to the development of technology, thus improving human capital. More than anything else, it has been the spectacular growth in East Asia that has given education and human capital their current popularity in the field of economic growth and development. Countries such as Hong Kong, Korea, Singapore, and Taiwan have achieved unprecedented rates of economic growth while making large investments in education. In the statistical analysis that accompanied his study, the World Bank (1993) found that improvement in education is a very significant explanatory variable for East Asian economic growth. There are several ways of modeling how the huge expansion of education accelerated economic growth and development. The first is to view education as an investment in human capital. A different view of the role of education in the economic success is that education has positive externalities; educate part of the community and the whole of it benefits.

The idea that education generates positive externalities is by no means new. Many of the classical economists argued strongly for government�s active support of education on the grounds of the positive externalities that society would gain from a more educated labour force and populace. Smith (1976) reflects such progressive contemporary thought when he wrote that by educating its people, a society derives no inconsiderable advantage from their instruction. The more they are instructed, the less liable they are to the delusions of enthusiasm and superstition, which, among ignorant nations, frequently occasion the most dreadful disorders. Instructed and intelligent people are always more decent and orderly than ignorant ones. Smith views the externalities to education as important to the proper functioning not only of the economy but of a democratic society.

Application of Human Capital Theory to Educational System

In order to enhance human development in the general society, it is necessary to apply the theory of human capital to educational systems. By such means, productivity is enhanced and sustained based on an increased and diversified labor force. Babalola (2003) asserts that the contribution of education to economic growth and development occurs through its ability to increase the productivity of an existing labor force in various ways. Therefore, economic appraisal of educational investment projects should take into account certain criteria,

According to Psacharopoulos and Woodhall (1997):

  1. Direct economic returns to investment, in terms of the balance between the opportunity costs of resources and the expected future benefits;
  2. Indirect economic returns, in terms of external benefits affecting other members of society;
  3. The private demand for education and other factors determining individual demand for education;
  4. The geographical and social distribution of educational opportunities;
  5. The distribution of financial benefits and burdens of education.

Education plays a great and significant role in the economy of a nation; thus, educational expenditures are found to constitute a form of investment. This augments individual�s human capital and leads to greater output for society and enhanced earnings for the individual worker. It increases their chances of employment in the labor market, and allows them to reap pecuniary and non-pecuniary returns and gives them opportunities for job mobility. Education is a source of economic growth and development only if it is anti-traditional to the extent that it liberates, stimulates, and informs the individual and teaches him how and why to make demands.

Human Capital Development in the Caribbean

Almost 55 million people of Latin America and the Caribbean were suffering from some sort of malnutrition early in this decade. Furthermore, 11% of the population is under-nourished; almost 9% of children under five years suffer acute malnutrition, and 19.4% from chronic malnutrition. In 2002, the region�s labour markets were heavily influenced by the contraction and/or slowdown in economic activity. The unemployment rate increased for the second year in a row, the generation of formal employment was weak and most new jobs were concentrated in low productivity sectors, and unemployment reached a record high 8.9% of the workforce. In addition, per capita GDP for the remainder of 2003 was estimated at 2% below its 1997 level, resulting in a decline for the sixth year in a row for the region�s economic growth (ECLAC, 2003).

The reality is that there is a decline in the region�s economic growth, high unemployment rates, lower employee productivity, and high levels of poverty facing the region. CARICOM nations are being forced to implement necessary changes to compete more strategically in the global economy. Change can also be viewed as an imperative to foster economic growth and being the player in the new global environment. Research and consultations suggest six causes of economic development: (a) foreign trade, (b) technological transfer, (c) resource allocation, (d) human capital formation, (e) structural transfer, and (f) savings an investment. Given the harsh reality and the lack of capital to invest, the focus switched to increasing employee, organizational, national, and regional productivity through human capital formation and how the identified strategies would enable CARICOM to be a player in the global economy and foster economic and social growth within the region (ECLAC, 2003).

Human development is seen as the enlargement of human capabilities, where the strategy is to promote investment in the development of people through education, skills, work productivity, and creativity. The resulting development of human, along with physical and natural capital, serves as a means to promote economic development. The issue is determining the most effective ways to use the least resources to create human capital through human development strategies. Human capital must be trained, educated, and developed within the system of an organization for the purpose of enhancing productivity of the organization through the expertise of its workforce (Zidan, 2001).

In a comprehensive study of economic strategies of the more developed Caribbean nations, it was highlighted that transformation of existing systems, policies, and practices within CARICOM nations will be difficult to achieve of governments do not place more emphasis in their educational curricula on subjects that will lead to the emergence of greater economic growth. In an era where the Caribbean organizations are faced with changes generated by globalization, there is an imperative need for human resource to be competent in participating in new modes of competition. Education is essential not only to enable people to share in the benefits of progress, but also to enable economies to ensure sustained development through competitiveness based on more intense knowledge use (ECLAC, 2003).

There is a widening gap between the Caribbean and both developed and emerging economies. In the Caribbean and Latin America, higher education is enduring a prolonged crisis where universities lack critical resources, technology and even intellectual capability to effectively prepare employees to compete in the global economy. The region has approximately 26% of the eligible individuals enrolled for post-secondary education. Many academicians and even politicians firmly believe that without a quality education, employees would not be able to produce at levels needed to compete in the global market and as such, there is an immediate need for focusing on education as a growth strategy. Compared with curriculum in developed nations, there is also a need to focus on what is relevant in the business, cultural, political, and social environments. Business, political, and religious leaders also play a critical role in ensuring that children are staying in school. In many parts of the Caribbean, young children are spending all day at farms, fishing, or just staying at home versus going to school. These are the same individuals who companies will be hiring as employees and who are supposed to produce goods and services to customers around the world. It is plainly a system that fails to educate the population, hence a workforce that lacks the education, knowledge, and skills necessary to perform effectively. It is for these very reasons that education is one of the pillars of proactive social policy aimed at the implementation of the universal principles enshrined in the human rights declaration and United Nation�s World Summit (United Nations, 2002).

Human Capital Development in the Caribbean and the rest of the World

According to modern growth theory, the accumulation of human capital is an important contributor to economic growth. Numerous studies explore whether educational attainment can contribute significantly to the production of overall output in an economy. Although macro studies have produced inconsistent and controversial results, several micro studies that look into the same problem have shown a consistent positive relationship between education of the workforce and their labour productivity and earnings. The general finding is that individuals with more education tend to have better employment than those who are less educated. These findings provide a strong rationale for government and households to invest substantial portions of their resources in education, with the expectation that higher benefits will accrue over time. In that context, education is deemed an investment, equipping individuals with knowledge and skills that improve their employability and productive capacities, thereby leading to higher earnings in the future (Trostel, Walker, & Woolley, 2002).

Human capital plays a critical role in economic growth and poverty reduction. From a macroeconomic perspective, the accumulation of human capital improves labour productivity, facilitates technological innovations, increases returns to capital, and makes growth more sustainable, which in turn, supports poverty reduction. Human capital is regarded at the macroeconomic level as a key factor of production in the economy wide production function. From a microeconomic perspective, education increases the probability of being employed in the labour market and improves earnings capacity. At the micro level, human capital is considered the component of education that contributes to individual�s labour productivity and earnings while being an important component of firm production. In other words, human capital refers to the ability and efficiency of people to transform raw materials and capital into goods and services and the consensus is that those skills can be learned through the educational system. Human capital development is important for development for its intrinsic value as a development goal in its own right (Cohen & Soto, 2007).

For the purpose of this paper, average years of schooling is the measure being employed as a measure of human capital because: (i) this can be measured for the entire workforce in most countries, (ii) it is fairly comparable across countries, and (iii) it is the most commonly used measure of human capital in research literature. Despite possible limitations, average years of schooling is still the most consistent and comparable country-level measure of human capital.

Stock of Human Capital in the World.

Barro and Lee (2010) used comparable data to estimate the current stock of human capital in the world; focus is on population aged 15 years and over. The data set covers 146 countries during the period 1950-2010. The table below presents data in eight different regions and by gender. The gender disparity is defined as the ratio of female and male average years of schooling.

Central Asia9.359.999.69
East Asia and Pacific8.478.018.24
Eastern Europe10.249.9510.09
Industrialized Countries10.9210.7110.81
Latin America and Caribbean8.638.338.48
Middle East and North Africa8.057.287.65
South Asia6.414.795.62
Sub-Saharan Africa5.984.895.43

The average number of years of schooling in the world is 8.12 years, with males having 8.41 years of schooling and females 7.84 years of schooling. A person in an industrialized country has the highest length at 10.81 years, while a person in Latin America and the Caribbean has an average of 8.63 for males and 8.33 for females. There is a need for a strong policy thrust if those disparities in human capital are to be bridged.

Central Asia1.241.671.46
East Asia and Pacific1.382.281.76
Eastern Europe1.051.401.23
Industrialized Countries.901.06.98
Latin America and Caribbean1.641.811.72
Middle East and North Africa2.663.723.05
South Asia2.002.752.26
Sub-Saharan Africa2.673.182.89

Industrialized countries have much higher stocks of capital than developing countries, so the nest question is whether or not past performance in human capital accumulation indicates eventual convergence. Human capital convergence has been observed in past decades as developing countries continue to show an increase in growth rates.

Education has been considered a key determinant of economic growth; the central role of technology has provided the impetus for the focus on education. There seems to be a strong correlation between an educated population and technological innovation. The link is made explicit in what is termed investment in humans: workers needed education in order to utilize new technologies, thereby increasing the total productivity and inducing economic growth. The accumulation of human capital through education and on-the-job training fosters economic growth by improving labour productivity, promoting technological innovation, and adaptation.

Barro and Lee (2010) estimated that increasing average years of schooling by one year increases per capita GDP by 1.7% to 12.1 %, depending on specification; Cohen and Soto (2007) calculate returns to years of schooling at 12.3% to 22.1%. Testing the impacts of schooling quality on growth, it was found that a unit increase in a country�s average cognitive test scores increases per capita GDP growth rate by 1.2 to 2.0 percentage points. Moreover, increasing average math and science scores by one unit increases per capita GDP growth rates by 2.0 points, and by 2.3 points for low-income countries. Overall, studies found that education significantly and positively correlated with economic growth and argue that causation runs from education and growth in line with human capital growth models.

Implications of Human Capital Theory for Educational Development

It has been proven that the human capital theory and educational systems work beautifully for the development of individuals and nations, especially developing nations. However, there are implications involved, especially in relation to the differences in policies and expenditures in education. The human capital theory emphasizes the need for policy makers to allocate significant resources to the expansion of educational systems. While some governments may be reluctant to invest in education, the positive returns from this investment will significantly outweigh the costs. Many of the developing nations have thus realized that the principal mechanism for developing human knowledge is the education system. Thus, they invest huge sums of money on education, not only as an attempt to impact knowledge and skills to individuals, but also to impart values, ideas, attitudes and aspirations which may be in the nation�s best developmental interest.


Since the purpose of a minimum standard is to offset the effects of poverty, appropriate subsidies could in principle achieve the same result without compulsion.� The effectiveness of voluntary investment in human capital is often underrated because subsidies to human capital usually cover, at best, only a portion of earnings forgone. If they cover all costs, including those forgone, almost all children, would continue in school through the age desired.

Developed and developing countries are confronted by most of the problems that could limit the capacity of expansion in education to stimulate growth and development. Some of these problems are: underemployment, low absorptive capacity, shortage of professionals, regional imbalances, and brain drain. The persistence of many problems in spite of the various policy formulation and responses points to the need for a more focused, responsive, functional, and qualitative educational system. To contribute significantly to economic growth and development, education must be of high quality and also meet the skill-demand needs of the economy.

It is not a noble achievement for any sector of the economy to exist for years only to make a negligible contribution to economic growth, which is not commensurate with its life span and investment. There is a need for more commitment by the authorities not to interfere with decisions such as curriculum or teachers� responsibilities. Parents should not wish to fulfill their life expectations in their children by selecting careers for them or by suggesting subjects that they should study. They should also not encourage or assist their children to purchase certificates. Government, in its employment policies, should lay more emphasis on specialization and competence rather than paper qualification and ill-gotten certificates.

In the Caribbean, there are some serious consequences for not investing in education and that includes out of school youths; they are: (a) unmet development goals such as education for all, (b) underdeveloped and underutilized human and social capital, (c) loss of economic productivity, (d) increased unemployment and underemployment, (e) increased violence, crime, and risky behaviours, (f) exploitation and marginalization of youth, especially girls and young women, (g) reduced social cohesion and disruption in civil society, and (h) increased spending on remedial social welfare services and crime prevention.


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Published by: Eaugrads

Evangelical Alumni Foundation seeks to fulfill "The Great Commandment and The Great Commission" to GOD's great economy. Each of us has great purpose as Sons of God. We are many in one body. Together, we are firmly planted by streams of water to bear fruits in all seasons. We shall not lack no good thing. Deuteronomy 1:11 God's Spiritual Billionaire's! Brief about our founder of Eaugrads: "JESUS"... "His pursuit of us is Relentless, His desire to Fight on our behalf is never ending; Despite the day to day distractions, designed to stop us from reaching our destinies, we can be sure of this... what God starts; He Finishes." Amen! Ministered By Tanya Harris, LLD

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