A Note on “Human Capital”

6 May 2014 at 9:18 am 8 comments

| Peter Klein |

Like Peter Lewin, Walter Block, Mario Rizzo, and Peter Boettke, I greatly admire the late Gary Becker, a pioneer in many areas of economics and sociology, a strong proponent of economic and personal freedom, and by all accounts a terrific teacher, mentor, and colleague. But I confess that I have always had qualms about the concept of “human capital,” along with the analogous constructs of social capital, knowledge capital, reputation capital, and so on. These are metaphors for capital in the narrow sense, and I worry that the widespread use of “capital” to denote anything valuable and long-lived obscures important issues about actual, physical capital that can be divided up, measured, priced, and exchanged. Witness the confusion over “capital” as Thomas Piketty uses the term. Here is something I wrote before:

[O]ne of my pet peeves [is] the expansive use of “capital” to describe any ill-defined substance that accumulates and has value. Hence knowledge, experience, and skills become “human capital” or “knowledge capital”; relationships become “social capital”; brand names become “reputation capital”; and so on. I fear this terminology obfuscates more than it clarifies.

I don’t mind using these terms in a loose, colloquial sense: By going to school I’m investing in human capital or diversifying my stock of human capital; if this gets me a high-paying job I’m earning a good return on my human capital; as I get old I forget new things, so my human capital is depreciating rapidly; and so on.

But we shouldn’t take these metaphors too literally. In economic theory capital refers either to financial capital or to a stock of heterogeneous alienable assets, goods that can be exchanged in markets and analyzed using price theory. Their rental prices are determined by marginal revenue products and their purchase prices are given by the present discounted value of these future rents. Knowledge is not, strictly speaking, capital, because it is not traded in markets does not have a rental or purchase price. What markets trade and price is labor services, and it is impossible to decompose the payments to labor (wages) into separate “effort” and “rental return on human capital” components. Some labor services command a higher market price than others because they have a higher marginal revenue product. Some of this wage premium may be due to intelligence or experience, some due to complementarities with other human or nonhuman assets, some due to hard work, and so on. But these are all determinants of the MRP, and hence the wage, not different kinds of factor returns.

Moreover, the entrepreneur needs cardinal numbers to compute the value of his capital stock, to know if it is increasing or decreasing in value, and so on. I can’t measure my stock of human capital, I don’t know for sure if it is increasing or decreasing over time, I can’t calculate the ROI of a specific human-capital investment, etc., because there are no prices and no measurable units. Knowledge may be “like capital,” in the sense that it lasts, that you can add to it, that you benefit from it, etc., but it isn’t literally a capital good like a machine or a refrigerator.

If we think going to school is valuable and increases lifetime earnings, why don’t we just say, “going to school is valuable and increases lifetime earnings,” rather than, “there is a positive return on investments in human capital”? Is there a good reason to prefer the latter, besides scientism?

Entry filed under: - Klein -, Austrian Economics, History of Economic and Management Thought, Jargon Watch. Tags: .

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8 Comments Add your own

  • 1. Dick Langlois  |  6 May 2014 at 9:44 am

    Peter, you may be interested to learn that Geoff Hodgson has just published a paper in the Cambridge Journal of Economics (doi:10.1093/cje/beu013) that has a similar complaint. Here is the abstract: “This article traces the historical usages of the term capital and the explosion of different types of supposed ‘capital’ in the twentieth century, including ‘human capital’ and ‘social capital’. In medieval and early modern times, capital meant money investable or invested in business. This meaning persists in business circles today. In contrast, Adam Smith treated physical assets, machines and people as ‘capital’ and this different usage has dominated economics since. The pre-Smithian meaning referred to money or other saleable assets that could be used as collateral. This article questions the change in meaning by economists and sociologists and highlights the importance of collateralisable property for capitalism. ‘Human capital’ can only be collateral if the humans involved are slaves. ‘Social capital’ can never be used as collateral and it is not even owned. These important issues are masked by the broadened notion of ‘capital’. Given the conceptual problems involved, economists and sociologists should consider returning to the pre-Smithian and surviving business usage of the term.”

  • 2. Peter Klein  |  6 May 2014 at 9:47 am

    Thanks Dick, I hadn’t seen Geoff’s paper but will check it out.

  • 3. michaelfto  |  6 May 2014 at 9:47 am

    You are making a good point, overall. And I like Piketty’s observation about needing a cardinal measure. Although, I think he means a unit measure.

  • 4. brendan  |  6 May 2014 at 3:27 pm

    Peter, in the hypothetical in which firms could literally own people, would your objections to the concept of human capital vanish?

    For example, you say capital needs to meet these requirements:

    “actual, physical capital that can be divided up, measured, priced, and exchanged.”

    Owned people can do all that.

    So it’s not the ephemeral nature of knowledge that distinguishes human capital from physical capital, nor the problem of “decomposing the payments to labor (wages) into separate “effort” and “rental return on human capital” components”.

    It’s just that human capital can only be rented, never sold. That’s the key distinction, right?

  • 5. Peter Klein  |  6 May 2014 at 4:12 pm

    Well, sort of. A human slave, like a machine, has a rental price equal to its discounted marginal revenue product and a purchase price equal to the present discounted value of the stream of future MRPs. So we could say that the slave owner, by purchasing additional slaves, is adding to his capital stock. (This is precisely the kind of thinking that got Fogel and Engerman into hot water!)

    But even so, adding intangibles into the picture is tricky. Under GAAP, if you own a truck and spend money to improve the performance of truck, you still have to add some kind of tangible, separable asset to capitalize, rather than expense, the improvement. Adding a toolbox or trailer hook or fuzzy dice is a capital investment; getting a tune-up or fresh paint or sending the driver to Skip Barber Racing School is a maintenance expense. You can certainly try to calculate an ROI on that expenditure, but you still have just one asset, a truck, not a truck plus some “truck-improvement-capital.” By analogy, if the slave master sends a slave to school, to increase the marginal productivity of that slave, is the expenditure on education an investment in the slave’s human capital, or more like a maintenance expense? Even if human beings can be bought and sold, it doesn’t seem to follow that human knowledge and relationships and reputation are themselves capital assets, other than things that increase the value of the human beings in which they are embodied.

    I’m sure there are accountants on this list who can help us out.

  • 6. Peter Klein  |  6 May 2014 at 4:59 pm

    As usual, Dilbert helps us frame the problem (via Russ Coff): http://dilbert.com/dyn/str_strip/000000000/00000000/0000000/000000/00000/2000/600/2602/2602.strip.gif

  • 7. Charlie Williams  |  22 May 2014 at 10:51 pm

    Good point – can we all so give up the metaphorical use of “market” for any system of social choice? Internal assignment of labor and capital in a firm is not accomplished by market mechanisms and it is confusing that we tend to call them “internal markets”.

  • 8. Peter Klein  |  22 May 2014 at 11:13 pm

    Charlie, that’s an interesting point — would we also have to give up the “political marketplace” and the “marketplace of ideas”?

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