What Is the Relationship Between Human Capital and Economic Growth?

Human capital and economic growth have a strong correlation. Human capital affects economic growth and can help to develop an economy by expanding the knowledge and skills of its people.

Human capital refers to the knowledge, skill sets, and experience that workers have in an economy. The skills provide economic value since a knowledgeable workforce can lead to increased productivity. The concept of human capital is the realization that not everyone has the same skill sets or knowledge. Also, the quality of work can be improved by investing in people’s education.

What Drives Economic Growth

Economic growth is an increase in an economy’s ability, compared to past periods, to produce goods and services. Economic growth is measured by the change in the gross domestic product (GDP) of a country. GDP is a representation of the total output of goods and services for an economy. For example, if a country has a GDP rate of 2.5% for the year, it means the economic growth of the country rose by 2.5% from a year earlier. In order to determine how human capital impacts growth, we must first look at two key drivers of economic growth in an economy.

Consumer Spending

It’s estimated that consumers are responsible for more than two-thirds of the economic growth in the U.S. economy. As consumers become employed or experience wage increases, they tend to increase their purchases of clothes, cars, technology, homes, and home goods such as appliances. All of that spending creates a positive ripple effect leading to improved employment in various industries such as retail, auto manufacturers, technology stores, and home builders, to name a few. The spending also leads to higher GDP growth throughout the economy.

Business Investment

The increased GDP growth from consumer spending leads to improvements in business conditions. As companies become more profitable, they tend to invest more money into their businesses to create future growth. Business investment can include new equipment and technology purchases. The investments businesses make are called capital investments. Capital investments, which require large outlays of capital or cash, are designed to boost a company’s productivity and profits in the long term.

In a growing economy, companies also take on additional borrowing from banks to expand production due to higher consumer demand. The loan proceeds are usually used for large purchases of assets such as manufacturing plants and equipment. The added production also leads to higher wages and increased employment as more workers are needed for the increase in consumer demand for a company’s products.

As companies look to hire workers to help with the increase in sales, it leads to new job openings in various types of employment. However, if the labor market becomes too tight, due to an expanding economy, companies are forced to train workers for the skillsets needed since there aren’t enough available skilled workers.

As a result of business investment, companies are more productive, while GDP growth rises since business investment is a key component of growth. Both consumer spending and business investment not only lead to more economic growth but also play a prominent role in determining the level of training and development of workers.

Human Capital and Economic Growth

Human capital is positively correlated to economic growth since investment tends to boost productivity. The process of educating a workforce is a type of investment, but instead of capital investment such as equipment, the investment is in human capital.

The Government’s Role

The role of governments is key to expanding the skillsets and education levels of a country’s population. Some governments are actively involved in improving human capital by offering higher education to people at no cost. These governments realize that the knowledge people gain through education helps develop an economy and boost economic growth. Workers with more education or better skills tend to have higher earnings, which, in turn, increases economic growth through additional consumer spending.

The Corporate Sector’s Role

Companies also invest in human capital to boost profits and productivity. For example, let’s say an employee working at a technology company receives training to be a computer programmer through on-site training and in-house seminars. The company pays for a portion of the tuition for higher education. If the worker remains at the company after the training has been completed, she may develop new ideas and new products for the company. The employee might also leave the company later in her career and use the knowledge she learned to start a new company. Whether the employee remains at the firm or starts a new company, the initial investment in human capital will ultimately lead to economic growth.

Human Capital Investments and Employment Growth

Investing in workers has had a track record of creating better employment conditions in economies throughout the world. If employment is improving, consumer spending rises, leading to increased revenue for companies and additional business investment. As a result, employment is a key indicator or metric for determining how GDP growth may perform.

The OECD or The Organisation for Economic Co-operation and Development is a group of more than 30 member countries that help to shape and develop economic and social policies across the globe.

OECD routinely analyzes the impact of education levels on employment and ultimately, economic growth. The OECD’s 2020 annual Education at a Glance report reviewed how education systems operate, the level of spending, and who benefited or participated. The OECD also measures how increases in education for men and women drive employment growth. 

In 2020, the OECD found that countries with people who had grammar and high school educations experienced an employment rate among 25-34 year-olds of 72% for men and 45% for women. However, those who had college or graduate education levels experienced an employment rate of 89% for men and 81% for women.

Although investment in human capital tends to produce more growth, it doesn’t necessarily mean the jobs are available for the newly-educated workers. Also, geography plays a role when it comes to job openings and the movement of labor. If job openings are located in the northern part of a country, but the skilled labor is in the south, growth could be hindered due to the cost of moving or the lack of desire to move.