Human capital theory: A jargon free guide

Sophie Heatley, Content Writer · 31 Aug

Human Capital Theory sounds like one of those lofty terms people are made to grapple with during CIPD training. But strip it back and you'll find HR professionals are putting the theory into practice everyday. Here's a jargon free guide to human capital.

Human capital sounds rather bookish, doesn’t it? But when you really get to the core of it, it isn’t as confusing as you might think.

What is human capital theory?

Human capital, by definition, is the stock of knowledge, habits, social attributes and personality attributes embodied in the ability to perform labour so as to produce economic value.

Come again?

Let’s make this a little more accessible.

Human capital is the study of human resources. This means it analyses the way in which economic value is derived from people in society. The basic theory of human capital is the following: just like we invest in the physical means of production, for example, in factories and machines, we can also invest in human capital, for example, through education, training and medical treatment.

Human capital

Just like a machine’s output depends largely on the amount of fuel we pump into it, a human’s output depends largely on the amount of support, social standing and training we provide the individual with.

In this way, human capital is also a means of production. If we invest in the worker, the worker will (hopefully) perform better, and the investment thus yields better results.

Human capital can be measured by the abilities and acquirements of the members of a society or corporation. It can be measured by the acquirement of talents, via education, study or other methods. These skills then fuel the creation of their individual fortune, and likewise, the productivity of the society to which they belongs.

How does human capital affect the outcome? 

There is therefore an immense correlation between the productivity and outcome of an individual and the resources the individual has/accumulates over his or her lifetime. These resources - be those general or specific knowledge, talent, training, personal or collective wisdom or experience - represent a form of wealth, so to speak, which can be directly exploited to accomplish the goals of a community, nation or state…

The history of theory

Gary Becker, who we have a lot to thank for, put the original concept together. He made people the central focus of economics.

Gary Becker was an American economist and empiricist. A professor of economics and sociology at the University of Chicago, he knew a thing or two about making money and social conventions. In fact, he knew so much that he went and got himself awarded a Nobel Prize in 1992, the Nobel Prize in Economic Sciences. He also received the United States Presidential Medal of Freedom in 2007.

Becker’s contribution to economics and sociology has had an astounding impact on how we view human labour and production.

Human capital theory

Since the original concept was introduced by Gary Becker. the theory surrounding human capital has evolved dramatically in the workforce.

While it may appear that humans are seen as products to sell, human capital management is actually about increasing a workers performance for the benefit of the organisation. Human capital is not about actually selling the worker at the end of the day (queue collective sigh of relief…).

Implementation of human capital theory and the role of line managers

This is where line managers come in. The duty of the line manager is to endorse performance management systems that enable the company to engage in a series of goal-setting, coaching and feedback processes with their employees.

The characteristics of human capital management can therefore be seen as a synonym for performance management in the workplace.

How do line managers support human capital management, or, if you prefer, performance management at work?

Line managers can influence the performance of their employees in many ways. There are a handful of simple but key elements involved in successful human capital management.

Attributes of successful human capital management

First of all, the line manager should have the ability and know-how to efficiently lead and direct his or her colleagues in the first place. A firm cannot expect its employees to gain sufficient knowledge or resources without having an example to follow.

This ability could be maintained through good organisational skills, a strong awareness of the performance of each and every employee that the line manager overlooks, and confidence in the line manager’s own ability to lead.

This can be shown through setting achievable, even if challenging, deadlines, understanding which employee needs what training and why, and having the capacity to make decisions based on the performance of employees which unreservedly serve to better the organisation as a whole.

The line manager should understand how to capture the value and mobility of knowledge and skills in a collective sense. The line manager should know how to get his or her employees to pool their knowledge and expertise. They must figure out how to make these human resources transferable.

The line manager should know the best way to give appraisal to employees, and should encourage them to work harder or train more. Employee satisfaction is a major indicator of how effective a human capital management system is.

Human capital line manager

...and the critique?

Satisfaction can generally be achieved through transparently and unambiguously communicating the goals of the system to each and every employee involved, as well as through making sure the employees feel valued. The employees must feel they are appreciated. Not just as business resources, but as human beings.

While it cannot be ignored that employees have economic value, it's this demoralisation that's the foundation of many criticisms of human capital theory. People don’t like being referred to as tools.

Talent is an intangible asset. Another criticism of human capital theory is that it's hard to measure. This is often why performance-related pay can be a slippery slope of accusations against prejudice or favouritism.

Talent is, of course, valuable. But how can businesses measure this value in financial metrics? How can firms create a working culture that aims to encourage talent without reducing the workers to economic products?

How to measure the success of Human Capital Management

The key is to put people first. The strength of any human capital management strategy is largely dependent on the satisfaction of the system on an employee level. Research has proven that it's the efficient and effective management of people within organisations that ultimately increases firm performance and encourages positive individual outcomes.

The way the employees view the performance management system in place will also influence the effectiveness of the system. If the employees do not feel motivated or engaged in the system provided by their line manager, the line manager will be unable to fulfil their duty of improving the performance of the business as a whole.

Along the same lines, the line manager should be motivated to perform his or her managerial role too. The line manager’s motivation is contagious, and will encourage the employees to continue to accumulate useful resources – be that through professional training or self-help – which can contribute to the value of the company.

In order for this to be successful, though, the line manager must provide their employees with opportunities to develop themselves as valuable resources to the company in the first place. The line manager should offer training, feedback groups, meet-ups or any other kind of opportunity that serves the nourishment of the employees’ stock of talents.

Measuring human capital

Human Capital Theory: Education

These kinds of practices and motives can be seen all around us. For instance, there are strategic systems set in place at many, if not all, educational institutions. Governments worldwide have legislated performance management systems at schools to ensure the high-quality education of our future generations. Like line managers, Headmasters must regularly plan, monitor and evaluate the performance of their teachers.

Human Capital Theory: Sport

Another sound example of the bargaining power of human capital can also be found on the field. Footballers, for example, who are world champions, will have a greater value on the market than footballers in the lower leagues. Just like office politics, the best players provide the best economic value. Investing in their performance is likely to lead to better scores, and better results in the league tables.

Human Capital Theory: Banking

In the financial sector, human capital management systems are aimed at helping firms to achieve a competitive advantage and to advance individual and collective performance within the organisation.

Since human capital has the potential to vastly determine the quality of output, the improvement of training and coaching can have serious financial motives. Indeed, studies have shown clear links between the stock of human capital resources and the financial performance at firm-level.

The Goldman Sachs Group in an American multinational investment bank and financial services company. They have a major human capital management platform. Their platform aims to “attract, develop and manage a global workforce”.

The purpose of their human capital management team is not only to strive to recognise the level of loyalty and dedication provided by the people working at the company, but to dedicate the company to making sure their experience as employees of Goldman Sachs is rewarding and fulfilling.

Goldman Sachs offer learning opportunities, a strong framework for career development, and a health and wellness support system. Goldman Sachs also promises to maintain a diverse and inclusive community for all their employees.

Human capital managemebt

Their practice aims to create an environment, which supports the pursuit of top-performances, as well as provide the space and resources for their people to thrive. The platform seeks to encourage interaction between all levels of employees, in a variety of business areas.

This boosts their employees’ communicational and analytical skills, by exposing them to the many integral layers of the company, and emboldens their employees’ sense of self-worth, integrity, and collaborative creativity.

This takes place everywhere within the company, from the deepest depths of the companies core to the outer layers, where the recruiters and talent scouts survey the horizons for potential future candidates.

Communication is their priority. They develop their people through learning and feedback, in a person-by-person approach. Their talent development teams carry out frequent talent assessments and development initiatives to address the ever-changing and unique culture of Goldman Sachs.

Positive initiatives and performance appraisals are the way forward

The issue of human resource management has been a long-debated topic for business and professional organisations.

In conclusion, human capital management should not be met with resistance. When analysed through a purely economic lens, human capital may seem somewhat inhumane. But firms must recognise, like Goldman Sachs have, that by using human capital management, they can create a healthy working culture that encourages employees to develop and pool their talents together.

Human capital culture

A sound human capital management practice can build customer confidence, employee self-confidence (by reaffirming their talents and self-worth within the organisation) and therefore, an increasing sense of loyalty and dedication to the outcome of the firm as a whole.

If the employees feel valued, the employees will value and add value to their organisation

Through performance-enhancing training and practical human capital management, employees will be better equipped to make independent decisions for the collective wealth and success of the business as a whole.

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