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Human Capital Formation: Meaning, Sources, Role and Importance

Last Updated : 26 Apr, 2023
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If seen from the economic development point of view, human resources are important. In today’s world, it is believed that to build a strong nation, it is essential to focus on the development of people and the organisation of human activity. Here, the development of human resources refers to the increase in the quality of human beings to help in the growth process and development of the country.

According to Prof. Whipple, ‘A nation’s true wealth is neither in its land and water, nor in forests and mines, nor in its flock and herds, nor in dollars, but in its wealthy and happy men, women, and children.’

Human Capital Formation


How do people become resources?

People become resources when the individuals who are part of the workforce contribute significantly to economic progress by contributing to the country’s productive resources. Thus, in addition to numerous other resources, a country needs people who can put those resources to good use and improve output. Human capital is invested in via training, education, and healthcare making the worker more productive and hence more useful to the economy, this way people become resources because of the skills they learn, the knowledge they apply, the productivity they offer and their abilities.

What is Human Capital?

Human Capital is the stock of talent, competence, expertise, education and knowledge embodied in a nation’s people at some point in time. In simple terms, it is a stock of professionals and skilled individuals in a country at any one moment who engage in the production process and contribute to the gross domestic product. The Human Capital of a country includes engineers, doctors, management employees, teachers, labourers, etc.

What is Human Capital Formation?

To produce more human capital from resources, we need to invest in human capital. The process of adding to the stock of human capital over time is known as Human Capital Formation. In other words, Human capital formation is the process of acquiring and expanding the number of competent, educated, and experienced people who are essential to the country’s economic, social, and political development. Thus, human capital formation is associated with an investment in human beings and their development as a creative and productive resources.

For example, if at the beginning of the year, a country’s human capital stock includes 40 lakh skilled workers and at the end, it increases to 45 lakh skilled workers, then there is human capital formation to the extent of 5 lakh skilled workers in a year.

Sources of Human Capital Formation

Human capital of a country can be increased with the help of different ways. Some of the sources of human capital formation are as follows:

1. Expenditure on Education 

The most effective way to improve and enlarge the size of the nation’s productive workforce is by spending on education which makes it a significant source of human capital formation. Countries and people spend money on education with the objective of: 

  • Enhancing their potential earnings.
  • Producing technological expertise and human resources that are ideal for boosting labour productivity and thus, supporting the rapid development of the economy.
  • Getting better social standing and pride.
  • Facilitating adaptation of new technologies.

2. Expenditure on Health

Complete physical, mental, and social well-being is a condition of being in good health. The quality of the manpower is negatively impacted by poor health and underemployment because sick workers who lack access to medical facilities are compelled to take time off of work which reduces productivity. The quality of human capital improves when individuals have access to enough food and good nutrition, as well as adequate health and sanitation services. Therefore, a healthy person makes a more substantial GDP contribution than a sick person. 

DIfferent expenditure on health includes Preventive care (vaccination), Curative medicine (used when unwell), Social medicine (health literacy promotion), Clean drinking water supply, and Good sanitation facilities. 

3. On-the-Job Training 

On-the-job training is an essential source of human capital formation as the return on investment in the form of increased labour productivity is greater than the cost. This can happen in several forms:

  • Workers may be trained in the firm under the supervision of a qualified worker, or
  • Workers can be sent off-campus for training.

Firms incur costs in each of these scenarios. Once the training is over, the firms requires their workers to work for a set amount of time in order to enjoy the benefits of increased production. 

4. Expenditure on Migration 

People migrate in search of occupations that pay more than what they earn in their home places. For example, Engineers and physicians migrate to other countries in search of a higher salaried job. Unemployment is the driving force behind rural-urban migration in India. It means that unemployed people from the rural areas move to urban areas in search of jobs. Similarly, technically qualified people like doctors, professors, engineers, etc., migrate to other countries in search of a job with higher salary. In both cases, migration entails the expense of transportation, the greater cost of living in the migrated location, and the psychological costs of living in an unfamiliar socio-cultural setup.

5. Expenditure on Information 

People spend money to learn about the labour market and educational institutions. For example, people need information regarding different salary levels associated with different types of jobs, etc. This type of information is required to make decisions about education investment as well as to make optimal use of learned skills and help people to realise their productive potential. Thus, expenditure on acquiring information regarding labour markets and other sectors such as education and health is a source of human capital formation.

Role and Importance of Human Capital Formation

Economic growth is defined as an increase in a country’s real national income. A literate person contributes more to economic growth than a person who is illiterate. Therefore, human capital formation is important for an economy. Some of the points that describe its importance are:

1. Improvement in Human Capital Productivity: Human capital formation through education investment increases productivity and output by assuring workers are aware and skilled. People’s technical skills which are acquired only through investment in education or training, as well as their general health, are essential for increased productivity and quality output.

2. Improvement in Quality of Life: The degree of education, health, and skill development of a person determines the quality of life. Human capital development not only makes individuals more productive and creative, but it also impacts their lives for the betterment. People’s quality of life improves as a result of better education, health, and skill development. Human capital formation allows people to enjoy a greater standard of living since they are able to generate higher salaries for themselves which help in economic development.

3. Modernisation of Attitude: People become more knowledgeable, competent, and modern as a result of investments in human capital. It changes their perspective and attitude towards multiple aspects of the country’s growth such as traditions and job markets. It leads to the establishment of modern society for economic development.

4. Effective use of Physical Capital: A person who is properly trained and has the necessary skills will have a better understanding of the physical tools and equipment, as well as the best methods to use them.

5. Important Role in the Development Strategy: In its seventh plan, 1985-1990, India prioritised human capital. Trained and educated individuals, in accordance with human resource development, have become an asset in enhancing economic growth and assuring social transformation in the desired direction.

6. Improvement in Technology: The education system focuses on boosting human resource productivity through technological advancement at all levels of work. It promotes people’s receptivity to modern and scientific concepts. Since independence, the number of technical and professional educational institutions has grown significantly. Thus, with an advanced educational system, the utilisation of advanced technologies in the production process becomes easier.

7. Increased Participation and Equality: A person with the ability to acquire knowledge and specialist skills has higher employment opportunities. This increases production efficiency and worker participation in economic, social, and political activities. This high rate of participation shows that a country has a high degree of economic and social equality. 

8. Increases Life Expectancy: By focusing on health facilities and making nutritive food available to people, human capital formation increases the life expectancy of people as it enables them to live a healthy, long, and happy life. 

9. Control of Population Growth: It is common to see that an illiterate family has a large family as compared to an educated family. Therefore, expenditure on education through human capital formation helps in educating people and spreading awareness among them regarding the need of controlling the population growth rate.

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