Chapter 5: HUMAN CAPITAL FORMATION

INTRODUCTION

Definition: The development of human resources means an increase in the quality of human beings, which helps in the process of growth and development of the economy.

Physical Capital and Human Capital

• Physical Capital: It includes all those inputs, which are required for further production, like plant and machinery, factory, buildings, raw materials, etc.

• Physical capital is needed to make use of physical resources.
• Its accumulation is quite important for the economic growth of a country.
• The ownership of physical capital is the outcome of the conscious decision of the owner the entrepreneur possesses the knowledge to calculate the expected rates of return to the range of investments and then rationally decides which one of the investments should be made.
• Physical capital formation is mainly an economic and technical process
• Human Capital: It refers to the stock of skill, ability, expertise, education and knowledge embodied in the people.
• Human Capital is needed to make effective use of physical capital.
• There is a need for investment in human capital to produce more human capital out of human resources.
• Societies need sufficient human capital in the form of competent people who have themselves been educated and trained as professors and other professionals. In other words, we need good human capital to produce other human capital (say, doctors, engineers, etc.)
• A country can turn physical resources like land into physical capital like factories. Similarly, it can also turn human resources like students into human capital like engineers and doctors. Both forms of capital formation are outcomes of conscious investment decisions.

Human Capital creates both Private and Social Benefits

• The nature of benefits from human capital is different from that of physical capital.
• Human Capital benefits not only the owner but also the society in general. For example, an educated person can effectively take part in a democratic process and contribute to the socio-economic progress of a nation. Similarly, a healthy person prevents the spreading of contagious diseases and epidemics by maintaining personal hygiene and sanitation. Thus, human capital creates both private and social benefits.
• On the other hand, Physical Capital creates only private benefits. It happens because benefits from a capital good flow to those who pay the price for the product and services produced by it.

Human Capital Formation

People become resources by using their skills, knowledge, productivity and abilities. When human resources is further developed b is further developed by becoming more educated and healthy, we call it 'Human Capital Formation.

MEANING OF HUMAN CAPITAL FORMATION (HCF):

Human Capital Formation refers to the development of abilities and skills among the population of the country.

• It is the process of acquiring and increasing the number of persons, who have the skills, education and experience.
• Human capital formation is associated with an investment in man and his development as creative and productive resources.

SOURCES OF HUMAN CAPITAL FORMATION

1. Expenditure on Education: Proper utility of manpower depends on the system of education and training of people.
   • Labour skill of an educated person is more than that of an uneducated person, which enables him to generate more income than the uneducated person. Economists have stressed the need for expanding educational opportunities in a nation as it accelerates the development process.
   • Spending on education by individuals is similar to spending on capital goods by companies. Individuals Education invest in education to increase their future income and raise their living standard.
   • Education contributes to economic growth because:

• Education confers higher earning capacity on people;
• It gives better social standing and pride; o
• It enables one to make better choices in life;
• It provides knowledge to understand the changes taking place in society;
• It also stimulates innovations;
• It facilitates adaptation of new technologies.

2. Expenditure on Health: Health expenditure is a source of human capital formation as it directly increases the supply of healthy labor force.
   • Poor health and undernourishment adversely affect the quality of manpower. Sick labor, without access to medical facilities, is compelled to abstain from work and there is a loss of productivity.
   • Therefore, expenditure on health is important to build and maintain a productive labor force and to improve the quality of life of people in society.
   • Adequate food and proper nourishment to people, along with adequate health and sanitation facilities leads to qualitative improvement in human capital.
   • Forms of Health Expenditure: The various forms of health expenditures include:
     • Preventive Medicine is known as vaccination;
     • Curative medicine, i.e. medical intervention during illness;
     • Social Medicine, i.e. spread of health literacy;
     • Provision of clean drinking water;
     • Good Sanitation facilities.
3. On-the-Job-Training: Productivity of physical capital is substantially enhanced with the improvement in human capital. Due to this reason, many firms provide on-the-job training to their workers.
   • Such training has the advantage that it can be provided fast and without much cost.
   • It increases the skill and efficiency of the workers and | the Employees' Provident Fund leads to an increase in production and productivity. Organization conducting
   • On-the-job-training may take different forms: Intensive training to enhance the skill sets of employees for
     • Workers may be trained in the firm itself under the desired performance supervision of a skilled worker;
     • Workers may be sent for off-campus training.
   • After on-the-job training of employees, firmly insists that the workers should work for a specific period so that they can recover the benefits of the enhanced productivity owing to the training.
   • It is a source of human capital formation as the return of expenditure on such training, the form of enhanced labor productivity, is more than the cost of it.
4. Expenditure on Migration: People migrate from one place to another in search of jobs that fetch them higher salaries.
   • Unemployed people from rural areas migrate to urban areas in search of jobs.
   • Technically qualified persons (like engineers, doctors, etc.) migrate to other countries because of the higher salaries that they may get in such countries.
   • Migration in both these cases involves two kinds of cost:
     • Cost of transportation from one place to another; and
     • Higher cost of living in the migrated places.
   • Expenditure on migration is a source of human capital formation as enhanced earnings in the migrated place are more than the increase in costs due to migration.
5. Expenditure on Information: Expenditure is incurred to acquire information relating to labor market and other markets.

• It involves amount spent on seeking information about educational institutions, their educational standards and the cost of education.
• 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.
• Information is necessary to make decisions regarding investments in human capital as well as for efficient utilization of the acquired human capital stock.

HUMAN CAPITAL AND ECONOMIC GROWTH 

• The contribution of an educated person to economic growth is more than that of an illiterate person.
• Similarly, a healthy person also contributes to economic growth by providing an uninterrupted labor supply for a longer period of time.
• Thus, both education and health, along with many other factors Scientific and technical like on-the-job training, job market information and migration, manpower: Rich ingredients of human capital increase the income-generating capacity of an individual.

HCF promotes inventions, innovations and technological improvements.

• Human capital formation (HCF) not only increases the productivity of human resources but also stimulates innovations and creates the ability to absorb new technologies.
• Education provides knowledge to understand changes in society and scientific advancements, thus, facilitating inventions and innovations.
• Similarly, the availability of an educated labor force facilitates adaptation to new technologies.

Difficult to Prove Cause and Effect relation between Human Capital and Economic Growth

• Due to measurement problems, it is difficult to prove that increase in human capital causes economic growth.
• For example, education measured in terms of years of schooling, teacher-pupil ratio and enrolment rates may not reflect the quality of education.
• Similarly, health services measured in monetary terms, life expectancy and mortality rates may not reflect the true health status of the people in a country.
• It means, it is difficult to establish a relationship between cause and effect from the growth of human capital (education and health) to economic growth. However, growth in each sector has reinforced the growth of every other sector.
• The relationship between human capital and economic growth flows in either direction.

• Higher income causes building of high level of human capital; and
• High level of human capital causes growth of income.

Development Indicators in Education and Health Sectors

The analysis of the indicators mentioned above shows that the human capital growth (as shown by improvement in education and health sectors) in developing countries has been faster but the growth of per capita real income has not been that fast.

Report by Deutsche Bank and World Bank

Two independent reports on the Indian economy have identified that India would grow faster due to its strength in human capital formation.

1. Report by Deutsche Bank: The Deutsche Bank (a German bank), in its report on "Globe Growth Centres", identified that India will emerge as one of four major growth centers in the world by the year 2020.
   1. It further states that human capital is the most important factor of production in today's economies. An increase in human capital is crucial to achieving an increase in GDP.
   2. With reference to India, it states that between 2005 and 2020, a 40% rise in the average years of education in India is expected.
2. Report by World Bank: The recent report of World Bank "India and the Knowledge Economy - Leveraging Strengths and Opportunities", states that India should make a transition (changeover) to the knowledge economy.
   1. If the Indian economy uses its knowledge effectively (as used by Ireland), then it is per capita income will increase from a little over US$1,000 in 2002 to US $3,000 in 2020.
   2. The reports further state that the Indian economy has all the key ingredients for making this transition. It has a large number of skilled workers, a well-functioning democracy and a diversified science and technology infrastructure.
3. Thus, the two reports point out the fact that further human capital formation in India will move its economy to a higher growth path.
4. India recognized the importance of human capital in economic growth long ago. According to the 7th Five Year Plan, Human capital must be assigned a key role in any development strategy, particularly in a country with a large population. Trained and educated population can become an asset in accelerating economic growth and in ensuring social change in desired directions.

India as a knowledge Economy

• The Indian software industry has been showing an impressive record over the past decade.
• Entrepreneurs, bureaucrats and politicians are now advancing views about how India can transform itself into a knowledge-based economy by using information technology (IT). Likewise, e-governance is being projected as the way of the future.
• The value of IT depends greatly on the existing level of economic development. It can make existing assets and processes more effective and efficient. However, for this, basic infrastructure needs to be developed.

IMPORTANCE OF HUMAN CAPITAL FORMATION

• Effective use of Physical Capital: The growth and productivity of physical capital depend extensively on human capital formation.

• Physical capital can be created only by means of hard and intelligent work of human beings in the economy.
• Hence, human skill and their efforts help in Modernization of Attitudes effective utilisation of physical capital.

• . Higher productivity and production: Human capital raises the productivity and production as knowledgeable and skilled worker makes better use the resources.

• Increase in productivity and quality production depends on technical skill of the people, which can be acquired only by means of education, training and maintaining the he of the people.

• Investment in human capital helps in acquiring new skills and knowledge relating to management of resources, technology and production.

• Inventions, innovations and technological improvement: The human capital formation stimulates innovations and creates ability to absorb new technologies.

• Education provides knowledge to understand changes in society and scientific advancements, which facilitates inventions and innovations.
• Similarly, the availability of an educated labor force facilitates adaptation to new technologies.

• Modernization of attitudes: The knowledgeable, skilled and physically fit people are powerful instruments of change in society.

• Economic development of a country depends on the minds of the people and their changing attitudes towards creating a 'will' for development.
• Investment in human capital helps in changing mental outlook and promotes development of the economy.

• Increases life expectancy: Formation of human capital raises life expectancy of the people. Health facilities and availability of nutritive food enable people to live a healthy and long life. This, in turn, adds to the quality of life.
• Improves Quality of Life: The quality of population depends upon the level of education, health of a person and skill formation acquired by the people.

• Human capital formation not only makes people productive and creative, but also transforms the lives of the people.
• People start living and enjoying higher incomes and life that is more satisfying.

• Control of population growth: It has been observed that educated persons have smaller families as compared to illiterate families. Therefore, spread of education is necessary to control the population growth rate.

PROBLEMS OF HUMAN CAPITAL FORMATION

1. Insufficient resources: The resources allocated to the formation of human capital have been much less than the resources required. Due to this reason, the facilities for the formation of human capital have remained grossly inadequate.
2. Serious inefficiencies: There is a lot of wastage of society's resources as the capabilities of educated people are either not made use of (in case of unemployment) or are underutilized (in case of underemployment). Massive illiteracy, non-education of many children, and poor health facilities are other inefficiencies, which have not been attended to adequately and properly.
3. Brain Drain: People migrate from one place to another in search of better job opportunities Care and handsome salaries. It leads to the loss of quality people like doctors, engineers, etc. who have a high caliber and are rare in a developing country. The cost of such loss of quality human capital is very high.
4. High growth of Population: The continuous rise in population has adversely affected mic quality of human capital. It reduces per head availability of the facilities.
5. Several imbalances: A greater proportion of resources have been diverted towards higher education, which is meant for few people as compared to primary and secondary education. Due to this reason, the general productivity of the economy has remained low.
6. Lack of proper manpower planning: There is an imbalance between the demand and supply of human resources of various categories, especially in the case of highly skilled personnel. The absence of such balancing has resulted in the wastage of resources.
7. Weak science and technology: In respect of education, the performance is particularly unsatisfactory in the fields of science and development of modern technology.

HUMAN CAPITAL AND HUMAN DEVELOPMENT

• Human capital considers education and health as a means to increase labor productivity. On the other hand, according to human development, education and health are integral to human well-being because only when people have the ability to read and write and the ability to lead a long and healthy life, they will be able to make other choices, which they value.
• Human capital treats human beings as a means to increase productivity. Any investment in education and health is unproductive if it does not enhance the output of goods and services. However, according to human development, human beings are ends in themselves. Human welfare should be increased through investments in education and health even if such investments do not result in higher labor productivity.

HUMAN CAPITAL FORMATION IN INDIA:

• Ours is a federal country with a union government, and state government’s local governments (Municipal Corporations, Municipalities and Village Panchayats). The Constitution of India mentions the functions to be carried out by each level of government.
• Accordingly, expenditures on both education and health are to be carried out simultaneously by all the three tiers of the government.
• Education and health care services create both private and social benefits. As a result, bout private and public institutions exist in the education and health service markets.

Need for Government Intervention:

• The expenditures on education and health make a substantial long-term impact and they cannot be easily reversed. For example, if a child is admitted to a school or health care center and required services are not provided in such an institute, then a substantial amount of damage would have been done before the decision is taken to shift the child to another institution.
• Individual consumers of these services do not have complete information about the quality of services and their costs.
• The providers of education and health services may acquire monopoly power and may get involved in exploitation. So, the role of the government is important to ensure that the private providers of these services adhere to the standards stipulated by the government and charge the correct price

Regulatory Authority

• In Education, the ministries of education at the union and state level and departments of education and various organizations like the National Council of Educational Research and Training (NCERT), University Grants Commission (UGC) and All India Council of Technical Education (AICTE) regulate the education sector.
• In Health, the ministries of health at the union and state level, departments of health and various organizations like the Indian Council for Medical Research (ICMR) regulate the health sector.

EDUCATIONAL SECTOR IN INDIA

The expenditure by the government on education is expressed in two ways:

• As a percentage of total government expenditure: It indicates the importance of education in the scheme of things before the government. During 1952-2014, it increased from 7.92 to 15.7.
• As a percentage of Gross Domestic Product (GDP): It expresses the proportion of income spent on the development of education in the country. During 1952-2014, it increased from 0.64 to 4.13.
• The increase in education expenditure has not been uniform and there has been irregular rise and fall. However, if we include the private expenditure incurred by individuals and by philanthropic (charitable) institutions, the total education expenditure will be much higher.

Important Points about Government Expenditure

• The government spends more on Elementary Education: Elementary Education (primary and middle school education) takes a major share of total education expenditure. Share of higher or tertiary education (institutions of higher learning like colleges, polytechnics and universities) is the least
• Expenditure on Tertiary Education is important: On average, the government spends less on tertiary education. However, 'expenditure per student in tertiary education is higher than that of elementary education. However, it does not mean that financial resources should be transferred from tertiary to elementary education. As we expand school education, we need more teachers who are trained in higher educational institutions. Therefore, expenditure on all levels of education should be increased.
• The difference in Educational Opportunities across States: In 2014-15, the per capita education expenditure differs considerably across states from as high as 34,651 in Himachal Pradesh to as low as 4,088 in Bihar. This leads to differences in educational opportunities and attainments across states.

Provision of Free and Compulsory Education

The Tapas Majumdar Committee, appointed by the Indian Government in 1998, estimated an expenditure of around 1.37 lakh crore over 10 years (1998-99 to 2006-07) to bring all Indian children in the age group 6-14 years under the purview of school education.

• In 2009, the Government of India enacted the Right to Education Act to make free education a fundamental right of all children in the age group of 6-14 years.
• The government of India has also started levying a 2% education cess on all Union taxes. The revenues from education cess have been earmarked for spending on elementary education
• In addition to this amount, the government-sanctioned a large outlay for the promotion of higher education and new loan schemes for students to pursue higher education.

EDUCATIONAL ACHIEVEMENTS IN INDIA

• Adult Literacy Rate: The adult literacy rate refers to the ratio of the literate adult population to the total adult population in a country.
  •  In the case of males, the adult literacy rate increased from 61.9% in 1990 to 81% in 2015.
  • In the case of females, the literacy rate was just 37.9% in 1990, which increased to 63% in 2015, which is still far below the satisfaction level.
• Primary Completion rate: It is the percentage of students completing the last year of primary school.
  • In the case of males, the primary completion rate increased from 78% in 1990 to 94% in 2015.
  • In the case of females, the rate increased from 61% in 1990 to 99% in 2015.
• Youth Literacy Rate: It is the percentage of people aged 15-24 who can, with understanding, read and write a short, simple statement on their everyday life.
  • In the case of males, there was a marginal increase in the youth literacy rate from 76.6% in 1990 to 92% in 2015.
  • In the case of females, the youth literacy rate increased from 54.2% in 1990 to 87% in 2015.

FUTURE PROSPECTS IN THE EDUCATIONAL SECTOR

• The literacy rates for both adults as well as youth have increased. However, the absolute number of illiterates is still as much as India's population was at the time of independence.
• In 1950, it was noted in the Directives of the Constitution that the government should provide free and compulsory education for all children up to the age of 14 years. Had we done this, we would have achieved 100% literacy by now.

Gender Equity:

• The differences in literacy rates between males and females are narrowing. It indicates a positive development in gender equity. However, women's education needs to be promoted:
• To improve the economic independence and social status of women; and
• Women's education makes a favorable impact on the fertility rate and health care of women and children.
• Therefore, we cannot be satisfied with the upward movement in the literacy rates, until 100%, the literacy rate is achieved.

Higher Education:

• The Indian education pyramid is steep indicating a lesser and lesser number of people reaching the higher education level.
• As per NSSO data, in the year 2011-12, the rate of unemployment among youth males who studied graduation and above in rural areas was 19%. Their urban counterparts had a relatively less level of unemployment at 16%. The most severely affected ones were young rural female graduates as nearly 30% of them are unemployed. In contrast to this, only about 3-6% of primary-level educated youth in rural and urban areas were unemployed.
• Therefore, the government needs to increase allocation for higher education and higher education institutions, so that students are imparted employable skills in such institutions.

Conclusion

The economic and social benefits of human capital formation and human development are well known. The union and state governments have been allocating substantial amounts for the development of the education and health sectors.

The spread of education and health services across different sectors of society should be ensured so as to simultaneously attain economic growth and equity. India has a rich stock of scientific and technical labor in the world. We need to improve it qualitatively and provide such conditions so that they are utilized in our own country