Human Capital Investment

There is no doubt that human capital investment, by which I mean the accumulation of skills and educational attainment, is a vital component of successful economic growth. 

A more highly educated and skilled workforce delivers greater levels of productivity and innovation, both of which drive prosperity in an increasingly complex working environment.

However, whilst there is no controversy surrounding the desirability of increased human capital investment as a driver of growth, there are plenty of controversies surrounding the optimal approach to promoting it.

On this page I will give an overview of what the research tells us about the efficacy of various types of initiatives in the western world that have aimed at promote education and skills as a means to raising economic output and the standard of living. I'll start with a categorization of the types of skills and education standards that employers look for in a prospective employee.

Education and skills

Soft Skills

Soft skills are the foundation upon which employability is built. It relates to a persons reliability, attitude, dress-code, punctuality, manner and so on. For many people these attributes might be regarded as common sense, but for many reasons it is the lack soft skills that can hold people back - especially in the most deprived communities.

My personal professional experience has equipped with some expertise on this matter, having worked for a team whose sole aim was to improve 'Employment, Skills and Inclusion' outcomes for people who were experiencing long-term unemployment in some of the most deprived communities in the Northwest of England. These were communities that had suffered from decades of decline in heavy industry, manufacturing, mining and other industries.

To give an example of what we were dealing with, consider this example. A colleague had arranged for some interviews to take place one morning for some entry level jobs that had become available. One candidate did not show up for his interview.

Some time later on in the afternoon my colleague received a telephone call from the missing candidate's mother who explained that the reason for the absence was due to this fellow having been out late the night before and had drunk a lot of beer with the result that he was still in bed and would need to rearrange his interview date!

Now, to you and I it might appear immediately obvious that no such rearrangement could ever be agreed under these circumstances, but this sort of thing is simply not understood by people who have grown up in households where no one has ever worked, where school attainment rates are extremely poor, teenage conception rates are sky-high, and truancy, vandalism, petty crime, drug use, and so on is rampant.

Basic Skills

Basic skills are the sort of skills that are taught in primary schools i.e. literacy and numeracy skills along with basic Information and Computer Technology skills. These too are increasingly essential in the workplace, and once again it is the most deprived communities in the west that tend to be lacking in these areas.

Vocational Training

Vocational training aims to improve the particular skills needed for a given occupation. Training schemes can be run in the workplace itself or in local colleges. The trainee may be someone who is unemployed, or someone who is employed and either being wholly funded or part funded by their employer to undergo the training.

There are different types of vocational training programs that cover a wide range of skills at varying levels form secondary education equivalence right up to post-graduate equivalence.

Academic Qualifications

Academic qualifications include school leavers qualifications at age 16, further education qualifications at pre-university level, and higher education qualifications at Bachelors Degree level all the way up to Doctorate level.

As with vocational training this type of human capital investment may be undertaken by part-time by employed people who are seeking to enhance their job-related skills, but more typically the people engaged in earning these qualifications are doing so on a full-time basis.

The Screening Hypothesis

Whilst research has concluded that human capital investment is a necessary component of optimized economic output growth, there are some serious shortcomings in the analysis of the effects of particular types of projects to promote it.

The screening hypothesis contends that a significant part of the observed benefits to individual who have undertaken courses to build their human capital is not real. The argument here is that it is not so much that courses to build skills and education have raised the productivity of the individual, but rather that employers simply use qualifications as an indicator of who will likely be a high quality employee and who will not.

This point is immediately obvious with regard to academic qualifications which have absolutely nothing to do with the particular job vacancy i.e. a degree in History for someone seeking employment in business consultancy. It turns out that there has been a huge proliferation in recent decades of students gaining higher education qualifications in subjects that have little to no practical relevance for the occupations open to them.

Vocational training is not immune to the screening hypothesis either, with many government created courses that teach out of date skills, non-relevant skills, or people who have no real interest in the skills they are being taught - but attend these courses under threat of losing welfare payments.

Teaching the wrong skills, to the wrong people, is obviously a big problem. Government mandates to artificially increase human capital investment projects are unlikely to yield the same benefits that accrue to self-motivated individuals who seek out opportunities to increase their vocation-related skills. Employers are highly adept at assessing which qualifications have real value, and which job candidates are truly motivated.

The incompetent hand of government has weighed heavily on the systematic degradation of educational standards in the UK for many years. GCSE pass rates (grades at 16 years of age) have risen almost on a yearly basis since the 1980s, and call me a sceptic if you like, but I see little evidence of a better educated or more highly skilled youth in the UK today - quite the reverse in fact. Simply stamping more people with qualification pass rates, and expecting them to be more productive because of it, is the height of stupidity but it appears to be government policy.

None of this is to underscore the true value of real skills and educational qualifications.

The Benefits of Human Capital Investment

The available research divides the benefits of human capital investment into three categories i.e. those for the individuals involved, those for the businesses involved, and those for the economy as a whole.

Individual Benefits

Although there is significant variance in the estimated wage increase associated with an extra year of training/education, the research suggests an average of something like a 5-10% increase in gross earnings. As indicated from my opening paragraphs, the benefits of extra learning depend on the nature of the what is being learned and by whom.

Assuming that the course of learning is genuinely worthwhile and not some fabricated nonsense from some sort of poorly thought through government project, then the results are more promising. It appears that secondary education qualifications deliver greater benefits than further education, which in turn deliver greater benefits than higher education. This indicates that there are diminishing returns to education overall, which seems reasonable.

There appears to be greater benefits for extra learning by individuals who are employed in those industries that experience rapid technological advances.

There is also evidence to suggest that a student's family/social background is a key factor that will influence his/her chances of gaining qualifications. Again, this is consistent with my own experience of working with people in the most deprived communities in England. Studies suggest that early intervention (as early as nursery school) may deliver permanent results later on in life that would otherwise be much harder, or impossible, to achieve.

Vocational training has been shown to deliver benefits that depreciate over time, suggesting that the skills earned may lose validity over time e.g. ICT training that becomes obsolete. Employer based training delivers the best results, and gives a much better chance that the individual will learn something of practical value.

Employer Benefits

To the extent that employees improve their skills that are relevant to their employer, then employers will benefit from human capital investment. Since many employers actively assist their employees to undertake specific types of training by paying either all or some of the costs of their training, it is safe to assume that the resulting productivity gains deliver greater profits for employers as well as better pay for employees.

When the training is a unique type of training that is not easily transferable to other businesses, especially competitor businesses, then firms will be more willing to pay the costs of that training.

For transferable skills there is a problem in that any firm which pays for the training of its employees will incur a cost that its competitors might benefit from i.e. when the employee decides to go and work for the competitor. This has long been a problem in the construction industry where an adequate number of apprenticeships is hard to achieve. For these transferable skills, it is individuals rather than employers who usually have to pay the full costs of training.

Benefits for the wider economy

Since many of the benefits of training and education are transferable from one employer to another, there are many 'spillover' benefits for the wider economy from human capital investment. This, in essence, is consistent with the predictions of Endogenous Growth Theory.

The existence of the spillover effects also constitutes a 'positive externality' which implies that, left to itself, the free-market will under-allocate resources for training/education. In other words, there is a role here for the government to subsidize the provision of effective education and training programs by paying for them out of general taxation.

There are, however, serious difficulties in calculating the full social benefits of particular types of human capital investment meaning that it is very difficult to accurately determine how much funding should come from taxation. Most of the western world fully provides state education up to age 16 out of taxation, and many countries heavily subsidize further and higher education.

There are also many economic development initiatives that fund vocational training programs to help build transferable skills, and there are some government projects targeting deprived areas that provide extra support for individuals suffering from long-term unemployment.

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