Tuesday, February 17, 2015

The misleading terminology of "human capital"

Among many services both great and small that Thomas Piketty’s “Capital in the 21st Century” has rendered to economics is his skeptical view of the terminology of human capital. That coinage was one of the biggest mistakes in economic nomenclature in the last 50 years. It was ideologically motivated and has contributed to conceptual confusion.

Since Adam Smith, economists have known that there is a difference between more and less skilled labor. Under skill, we include education (measured by years of formal schooling), experience (measured by the years one has worked) and, less precisely definable, knowledge. Whether using Marxian or neoclassical economic theory, people with greater skills are supposed to be paid more because they produce greater value.

It is this combination of education, experience and knowledge that economists Jacob Mincer and Gary Becker decided in the early 1960s to term “human capital.” There is nothing new in the phrase nor anything harmful as such. We can call a more skilled person a person with greater human capital or use any other term, as long as we know and agree on what we mean. Calling it “human capital” appears a mere terminological quirk: We could just as well say that a more skilled person has greater “skilz” or whatever we decide to call it.

So if the name that we give to more skilled labor, whether “human capital” or “skilz,” does not matter, why is “human capital” such a disastrous turn of phrase? There are two reasons. First, it obfuscates the crucial difference between labor and capital by terminologically conflating the two. Labor now seems to be just a subspecies of capital. Second and more important, it leads to a perception — and sometimes to the argument used by insufficiently careful economists — that all individuals, whether owners of real capital or not, are basically capitalists. Even if you have human capital and I have financial capital, we are fundamentally the same. Entirely lost is the key distinction that for you to get an income from your human capital, you have to work. For me to get an income from my financial capital, I do not.

If we are all capitalists now, then no one is.

To see this elementary fact, assume that you have human capital that yields $50,000 annually and I have stocks that also produce $50,000 annually. But to get the return on your human capital, you have to work eight hours a day for perhaps 250 days per year. I do not. The two things are clearly not ethically the same. Even economically, they are different. In order to get your $50,000 from your human capital, you will have to exercise an effort, which implies disutility, or loss of welfare. I do not. Thus in pure welfare terms, we are not equal because in economics, as in real life, leisure is preferred to work. Getting $50,000 effortlessly is surely better than getting it by daily drudgery. 

This leads to a confusion, in which all individuals, no matter how miserable and living hand to mouth from their daily labor, are treated as capitalists. If we are all capitalists now, then no one is: The janitor who gets up at 5 in the morning and returns home at 10 at night is no less of a capitalist than a person whose greatest daily effort consists in hitting a golf ball right.

This misleading confusion carries over to the level of society. A society in which the top 10 percent consists of the most skilled people who receive the highest salaries is fundamentally different from a society in which the top 10 percent is composed of people who collect checks from their properties. The latter was never — or at least not since the Enlightenment — considered a desirable society, because it led to the idleness of the rich, to the “consumption of trifles and baubles” (to quote Adam Smith) or to social instability. But this crucial difference is concealed under the misleading term “human capital.”

In short, the concept of human capital brought nothing new to economics. It just relabeled something that was known since the dawn of political economy. But it managed to do serious damage to our ability to understand capitalist societies. It fancifully transformed poor wage workers into capitalists, and it identified the society based on labor with the one based on incomes from wealth. Finally, in very narrow economic terms, the concept is wrong because it seems to imply that the level of utility received by the agent, who gets a given income from either human or financial capital, is the same — while it patently is not.

For all these reasons, the term “human capital” should in most cases be abandoned, and economics should return to what Adam Smith clearly defined as more or less skilled labor. The term “capital” should be used as it is used in common parlance and as it was used during more than 200 years of economics: for property distinct from one’s labor.

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