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Definition: human capital from The Hutchinson Unabridged Encyclopedia with Atlas and Weather Guide

Concept introduced by US economist Gary Becker during the 1960s to describe the skills and training present in the workforce of a company, or the population at large. Human capital can be increased by investment in training and education.

Summary Article: Human Capital
From Encyclopedia of Business Ethics and Society

Capital is an asset or advantage from which an economic return can be earned. Human capital is one of the various forms of capital. Human capital comprises an individual’s knowledge and skills. Human capital can be broken down into general and specific forms. General forms of human capital, as the name implies, refers to knowledge and skills that can apply to a variety of settings and situations. Examples include a person’s general mental ability and skills such as communicating, motivating, and informationprocessing that apply across settings and situations. Unlike general forms of human capital, specific forms of human capital tend to be of value only to targeted sectors or organizations. For these reasons, specific human capital is often further refined to reflect firm-specific and industry-specific dimensions. Firm-specific human capital refers to the knowledge, skills, and abilities that are particularly productive and valuable in working within the firm. Knowledge of internal operations of the firm, tacit knowledge of the eccentricities of various operational personnel, communication styles that are compatible with the culture of the firm, and the set of managerial skills “tuned” to the particular needs of the firm are all examples of firm-specific human capital. In comparison, knowledge of industry trends is indicative of a person’s industry-specific human capital. Human capital is particularly important in more developed economies where upward of 50% of a nation’s gross domestic product is knowledge based. Sectors such as the computer, software, pharmaceutical, and education industries are particularly dependent on human capital to compete.

Difference Between Human Capital and Other Forms of Capital

There are some key differences that distinguish human capital from more traditional forms of capital such as physical assets and financial capital. A key difference is that human capital resides inside individuals and individuals own their own human capital. While organizations may try to use an individual’s human capital, the ultimate choice to deploy human capital rests squarely with the individual. Closely related to this point is the fact that human capital is a mobile good. It can leave the firm temporarily; such is the case when a person leaves at the end of the workday or it can be lost on a more permanent basis (e.g., when an individual quits current employment to work for a competitor). Thus, a major goal of most firms, usually through the Human Resources (HR) function, is to encourage employees and managers to share their knowledge and skills with others inside the firm and systematize such knowledge in the firm’s routines and practices. When such sharing occurs, human capital is transformed from a private good to a public form of capital that the firm can choose to exploit for competitive advantage. A firm’s HR practices should, therefore, devise ways to develop, enrich, and retain human capital and ensure that human capital stays within the boundaries of the firm.

Another pivotal difference between human capital and more traditional forms of capital is that human capital can actually appreciate, not depreciate, with use. It is important to note, however, that just as human capital can work to the benefit of the firm, human capital can also work directly against a firm’s goals or mission. This phenomenon can take several forms. Specifically, whereas a production line or an oil field as forms of capital cannot refuse authority or become unmotivated, that very possibility is clearly evident with human capital. Said differently, human capital can resist authority or can even slow down or stop working with ebbs and flows of motivation. At its worst, human capital can be used to extort or exploit the firm in terms of theft, corruption, or sabotage. Indeed, over the last several years, there have been notable and well-publicized cases in which knowledge and skills were used to hurt, not help, a firm.

Another defining characteristic of human capital is that it is difficult to measure or assess. For instance, revenue per patent, percentage of employees holding an advanced degree, years of experience in a given profession, and turnover ratios have all been used to attempt to capture a firm’s human capital. Very generally, education and amount of training are among the most widely accepted measures of human capital. Traditional proxies of general, firm-specific, and industry-specific human capital include educational level and pedigree, firm tenure, and industry tenure, respectively. Most experts on human capital suggest that to understand the value of human capital to the firm, one needs to examine how human capital contributes to a firm’s competitive advantage.

Human Capital as a Source of Competitive Advantage

There are two broad theoretical perspectives that appear to embrace human capital as a source of firm competitive advantage. The first is that of the resourcebased view (RBV) of the firm. According to the RBV, a firm can create and sustain a competitive advantage mainly by possessing, developing, and using resources. Not all firm resources are created equal, however, and for a firm to enjoy a true competitive advantage, the resource must be valuable, rare, inimitable, and nonsubstitutable. Unlike traditional forms of capital, human capital seems to meet most of these conditions and, as a result, provides a source for competitive advantage. Human capital is especially important for firms operating in complex and dynamic competitive environments, where the ability to rapidly notice, access, acquire, and assimilate knowledge and capabilities is critical to have advantage over competitors. While competitors can more easily understand and duplicate a firm’s physical assets, it is very difficult to copy unique, complex, and tacit knowledge held by the employees of the firm. Therefore, both academics and managers tend to agree that human capital is the premier source of future competitive advantage for a firm. For instance, McKinsey and Company suggest that the most important corporate resources over the next 20 years will be talented individuals who are technically astute, globally aware, and sophisticated in thought. Economists and the like tend to agree by noting that traditional sources of advantage, such as financial capital and scale economies, are weakened by environmental forces such as globalization.

The other perspective closely related to the RBV described above is the knowledge and learning-based view of the firm. According to this perspective, firms enjoy advantages when they create new knowledge and then effectively use that knowledge in creating valueadded products and services for superior returns. This perspective suggests that knowledge that is tacit, complex, and causally ambiguous helps firms create and sustain competitive advantages. Since individuals are the primary source of a firm’s knowledge, firms with high levels of human capital and that can use such capital are likely to create and sustain competitive advantages. The processes of acquiring external knowledge and internally creating new knowledge are inherently human processes. Development of tacit, complex, and socially embedded knowledge is possible when a firm’s human resources engage in “dialogue” to create new knowledge. This circumstance also suggests that for a firm to engage in innovation and entrepreneurial discovery, it needs to possess and/or develop requisite amounts of human capital. Both the RBV and knowledge-based perspectives suggest that compared with more traditional assets such as land, plant, and equipment, human capital provides more unique and enduring advantage to the firm by contributing to innovation, strategy development, and superior execution.

While human capital is important across all levels and functions of a firm, human capital of senior executives is pivotal from the perspective of firm strategy and competitive advantage. Human capital of the chief executive officer, other members of the top management team, and the board of directors becomes extremely critical in strategic decision making. These individuals often use their human capital to develop and formulate a firm’s strategy. At the upper echelon of the organization, human capital is usually deployed to scan the internal and external environment, process relevant information for decision making, recognize and seize opportunities, and solve problems. Senior managers enjoy both tremendous scope and discretion in their decision-making process. In other words, when executives effectively deploy their human capital, they are likely to contribute to the firm’s strategic advantage. Because of this contribution, executive human capital is highly researched and is also highly correlated with executive compensation levels: Those with higher levels of human capital are rewarded in the highly competitive executive labor market with higher compensation packages.

Human capital is of unequal value to the firm. In particular, human capital can either be a core or a peripheral asset. Core human capital reflects an individual’s knowledge and skills that directly translate into firm benefits. Without core human assets, it is difficult for a firm to remain competitive. In contrast, some human capital is peripheral in nature, meaning that a person’s knowledge and skills only weakly or tangentially affect a firm’s ability to compete. Thus, the level of authority, the importance of the job, and the discretion afforded a particular person all influence how a person’s human capital affects a firm’s overall competitive stance.

Developing and Managing Human Capital

Human resource management practices (HR practices) can play a major role in ensuring the development, retention, and use of human capital for organizational advantage. One of the initial areas in which HR can have an impact on human capital is during the recruiting and selection stages of HR staffing. Rigorous and systematic selection standards ensure that a baseline level of human capital within the firm is achieved. Recruiting from diverse sources to include individuals from other firms and other industries is important since progressive firms attempt to seek and build a diverse set of skills and knowledge capabilities. Once individuals are hired and brought inside the boundaries of the firm, HR plays a critical role in developing human capital. Human capital can be developed through practices such as training, coaching, and mentoring. Indeed, a desired outcome of such efforts is an increase in learning, which improves individuals’ knowledge and skills. HR managers need to ensure that employees and managers use their human capital to achieve organizational goals and outcomes. Perhaps the best way to ensure that human capital is used to support organizational goals is through well-designed compensation plans. For instance, variable pay plans that tie pay to some measure of performance is a mechanism to motivate individuals to use their human capital in a way that benefits both themselves and the firm. Another proven way to promote the sharing and deployment of an individual’s human capital on behalf of the firm is to launch and administer a gainsharing type of plan. Gainsharing plans involve sharing financial gain between the employees and the firm for increases in productivity and profitability. One of the most notable benefits of gainsharing type plans is that they encourage employees at all levels to share their unique knowledge and skills on ways to improve processes through the “suggestion” component of a typical gainsharing plan. Without gainsharing plans that reward and recognize suggestions for organizational improvement, the knowledge and skills embedded within an individual are more likely to remain dormant and a private good. Finally, HR must ensure that their compensation plans are competitive with both the internal and external markets. If compensation equity is not monitored, HR runs the risk of losing their human capital to other firms, including competitors that are willing to pay more for an individual’s knowledge and skills.

One common problem facing a firm is the decision to make or buy human capital. Recent well-chronicled cases within the technology and Web sector suggest that this make or buy decision toward human capital is driving a phenomenon termed talent poaching. Talent poaching is when a firm allows a competitor to train, develop, and “make” human capital and then offers a higher compensation package to the individual to lure the human capital from the very firm that spent so much on creating and developing it. One unintended consequence of talent poaching is that firms have less incentive to invest in the making and developing of human capital because trained and talented individuals may be lured away by a competitor. Because of this reduced incentive, many individuals choose to develop their own human capital rather than expecting an organization to do so. Hence, developing human capital is now more of a personal responsibility as opposed to a corporate one.

The role of human capital may well rest in a firm’s ability to create social capital. When two or more individuals collaborate and share knowledge and skills, the human capital of the individuals is transformed to social capital, which can then be effectively used by the organization to pursue its strategies. This social capital is particularly important since sophisticated, refined, and potent knowledge is best achieved through combination, exchange, and collaboration. Also, some evidence suggests that tacit knowledge, a type of knowledge that is difficult to codify and also difficult for competitors to imitate, is best created when more than one person is involved. If, indeed, superior learning can only result from social interaction, then the imperative of the firm is to combine human capital in a manner that produces social capital. Keep in mind that the value of social capital is directly related to the quality of its inputs—namely, human capital. Thus, individuals with superior levels of knowledge and skills are a necessary, but not sufficient, condition for producing high values of social capital. An ancillary benefit of this human capital to social capital relationship is that social connectedness may help anchor or at least slow the mobility of human capital out of a given firm.

Ethical Considerations in Managing Human Capital

It is quite clear then that human capital should be managed; but what is particularly intriguing from an ethical vantage is the question of how human capital should be managed. Unlike traditional forms of capital, people holding human capital have emotions and feelings. For this very reason, attempts to manage human capital like other entities, such as factors of production that are bought and sold regularly, should be met with caution. If human capital is viewed primarily as a fixed asset that cannot be bought and sold in the market, firms would continuously invest in the development and utilization of human capital in their employees. On the other hand, if it is approached as a variable cost or asset that can be bought and sold through market transactions, companies may not invest in developing human capital and may even lose their existing human capital. Importantly, embedded in each orientation is an ethical concern regarding the inherent worth of an individual and a firm’s obligation to consider the emotional factor that also accompanies an individual’s knowledge and skills. Of course, this added emotional dimension is absent in traditional forms of capital and, for that reason, poses challenges to those who manage human capital.

If we think of human capital from an individual’s perspective, some additional interesting ethical issues arise. For example, it is likely that people with high human capital will have greater influence and bargaining power inside an organization. As a result, they may be able to bargain for higher compensation, which will further widen the already large compensation gap in the organization. Another interesting issue is the appropriation of the value created by human capital. If a person with high human capital creates a certain amount of value to a firm, how much of that created value should be received by the person versus the firm? Another issue concerns the treatment of humans as a “resource” or a “piece of capital.” Since business tends to exploit its capital and resources, there is a real danger that people will be treated as a resource that firms can increase and decrease whenever they want to do so. This approach could dehumanize the managerial ranks along with the labor force.

As long as developed nations continue to move away from traditional manufacturing as an economic engine in favor of technology, knowledge, and service type sectors, human capital will likely only increase in importance. Consequently, those who can effectively manage this unique form of capital are more likely to successfully compete in the new knowledge-based marketplace.

    See also
  • Employment Contracts; Empowerment; Executive Compensation; Intellectual Capital; Leadership; Networking; Reputation Management; Social Capital

Further Readings
  • Barney, J. Firm resources and sustained competitive advantage. Journal of Management, 17, (1991). 99-120.
  • Becker, G. S. (1964). Human capital. New York: Columbia University Press.
  • Cappelli, P. (1999). The new deal at work. Boston: Harvard Business School Press.
  • Coff, R. W. Human capital, shared expertise, and the likelihood of impasse in corporate acquisitions. Journal of Management, 28, (2002). 107-128.
  • Gnyawali, D. R.; Stewart, A. C. A contingency perspective on organizational learning: Integrating environmental context, organizational learning processes, and types of learning. Management Learning, 34, (2003). 63-89.
  • Harris, D.; Helfat, C. Specificity of CEO human capital and compensation. Strategic Management Journal, 18, (1997). 895-920.
  • Kogut, B.; Zander, U. Knowledge of the firm and the evolutionary theory of the multinational corporation. Organization Science, 3, (1992). 383-397.
  • Lepak, D. P.; Snell, S. A. The human resource architecture: Toward a theory of human capital allocation and development. Academy of Management Review, 24, (1999). 31-48.
  • Lepak, D. P.; Snell, S. A. Examining the human resource architecture: The relationships among human capital, employment, and human resource configurations. Journal of Management, 28, (2002). 517-543.
  • Offstein, E. H.; Gnyawali, D. R.; Cobb, A. T. A strategic human resource perspective of firm competitive behavior. Human Resource Management Review, 15, (2005). 305-318.
  • Yli-Renko, H.; Autio, E.; Sapienza, H. J. Social capital, knowledge acquisition, and knowledge exploitation in young technology-based firms. Strategic Management Journal, 22, (2001). 587-613.
  • Devi R. Gnyawali

    Evan H. Offstein
    Copyright © 2008 by SAGE Publications, Inc.

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