Human Capital Theory

Human Capital Theory

Human capital theory was initially developed in United States and Europe in the 1950s. Later, this theory was applied to undeveloped countries. The advocates of this theory were of the opinion that it is not only the physical capital stock, i.e., labour, which is important, but also human capital stock, such as education, which is critical to the growth and development of a nation. They argued that when people become more and more educated, they become more productive. There is a close relationship between the number of years of schooling and income level of a person.

In other words, increasing the level of schooling would lead to higher earnings. In essence, the human capital theory believes that people are willing to invest in education, which is an investment for the future. In other words, the human capital theory considers expenditure on education as an investment and not as expenditure. Not only the individual, but also the whole society would gain out of investment in education. Besides, the country will gain from the external effect of education, i.e., lower fertility rate and higher maternal and child health. Such positive external effects are a justification for public subsidies to education. Therefore, in almost all countries, both developed as well as developing, the cost of education is subsidized by the government.

Another aspect of human capital theory is that, it provides a framework for the systematic evaluation of costs and benefits of education to the households.

i) Cost of Education: The cost of education includes direct cost, and opportunity cost:
Direct cost, are school fees, cost of books, teaching materials, school uniforms, copies, etc. Opportunity cost is the income forgone while receiving education. Besides, it also refers to the income that an individual is losing from the labour market during the period he joins education institutions and, at the same time, bears the cost of education.

ii) Benefit of Education: The benefit of education is the gap between the lifetime income of an individual with a given amount of education and the lifetime income received if he had not this education. On the basis of cost and benefit, the role of return on investment on education is calculated. Research findings show that in developing countries, the rate of return on investment in education was higher compared to the rate of return in physical capital.

Limitations of Human Capital Theory

Human capital theory has several limitations.
• The relationship between education and increase in income is difficult to measure. This is because the increase in personal income is influenced by many factors other than education. Therefore, it is very difficult to measure marginal productivity, especially of human capital.

• It is difficult to measure cost and benefit analysis of human capital. Though the direct cost of education is easier to calculate, the opportunity cost and the estimation of income forgone are difficult to measure.

• The benefit of education is much more than economic and the social benefits of education.

• The demand for education does not only depend on costs and benefits, but on the ability to pay for education.

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