Human And Physical Capital
Definition
Human capital: the stock of skills, knowledge, experience and health embodied in a workforce that makes it more productive.
Physical capital: the man-made stock of machines, tools and buildings used to produce output.
- Both are called capital because each is a durable stock, built by investing today, that then yields a stream of output over many future years.
- Human capital lives in people, so it cannot be bought outright like a machine and leaves the firm when a worker does, which is why firms hesitate to fund training a rival might poach.
- Investing in either raises output per worker, and higher productivity pushes the economy's productive capacity outward.
Key Idea
- Physical capital is equipment, while human capital is the capability of workers.
- Both raise productivity and long-run growth, and they reinforce each other.
Telling Them Apart
- Tangibility
- Physical capital is tangible equipment that can be seen and sold, whereas human capital is intangible and embodied in people.
- Ownership
- A firm owns its physical capital outright, but rents human capital through wages and loses it when a worker leaves.
- Building the stock
- Investment in physical capital means spending on equipment, while investment in human capital means spending on education, training and healthcare.
Example
- A hospital's physical capital is its £1m scanners, beds and buildings, while its human capital is the training and skill of its doctors and nurses.
- A new scanner adds little output unless staff are trained to use it, so the two are complements.
Why It Matters
- Both forms raise labour productivity, and higher productivity shifts long-run aggregate supply and the production possibility curve outward.
- A shortage of one can hold a country back even when it has plenty of the other, so the two are complements rather than substitutes: gleaming machines are wasted without skilled operators.
- Which matters more depends on context: a developing economy may gain most from basic education, while an advanced one gains most from new technology.
Exam technique
- Define physical capital as equipment and human capital as worker capability, then give a clear example of each.
- Explain how investment in each raises productive capacity, rather than simply asserting that it does.
- Note that the two are complements, since skilled workers use better equipment more effectively.
Common Mistake
- Do not treat capital as only machinery, since human capital, the skills and health of workers, matters just as much.
- Do not see the two forms of capital as substitutes, since they work best together.
Self review
- Define physical capital.
- Define human capital.
- Give one example of investment in each.
- Explain how each raises productive capacity.
- Why are the two forms of capital complements?
