The misleading terminology of "human capital"

[Text published on Al Jazeera website February 13, 2015.]

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.

Between the two chimeras and a world war

As the world slowly slides towards the war in Ukraine, a war which will inevitably, like in a Greek drama, become, in a year or two, a nuclear and possibly a World War, one has to ask himself or herself how and why this has all happened.

           The main victim so far is Ukraine, but soon it will be the world as a whole. Ukraine was victim because, she, a divided country, was forced to choose between the western Europe and Russia. It fully belongs to neither. But moreover  it was offered the two chimeras: nothing real by either side, but just sufficient to annoy the other side.

            What precipitated the Maidan demonstrations, that were started by a peaceful and “nice” pro-European urban crowd and ended by being led by violent groups of neo-Nazis bent on “regime change”, was Yanukovich’s postponement (sic!) of the signing of EU association agreement. That agreement was as substantive for Ukraine’s European ambitions as was a similar agreement signed with Morocco almost twenty years ago. (Have you heard of Morocco being part of the EU?)

            No one can imagine that Ukraine has a chance of becoming even a candidate, much less a full EU member. Not only because it is poor and disorganized country, with declining national income, falling behind both Poland and Belarus (see the graph), and thus requiring enormous financial transfers Europe is clearly unwilling to make. It is also a country with corruption ingrained in all pores of society  with non-existent real political parties (except those created on an ad hoc basis by oligarchs, including the current president Poroshenko, or UDAR, party created by a boxing champion), with no semblance of independent judiciary. 

            The amount of negotiations and changes that the EU would have to impose on Ukraine to bring it to something even resembling the ever higher requirements EU demands from prospective candidates (itself a reflection of EU unwillingness to admit new members) is mindboggling. It is on a scale far greater than what was required from Turkey, the country which since 1963 was an associate member and opened “accession negotiations” with the Union 15 years ago. They have progressed at snail’s pace.

            Moreover, Ukraine is home (or was home) to almost 45 million people. It would be the fifth or sixth (ex aequo with Spain) most populous country in the EU. Europe which is already paranoid about receiving immigrants, even from within the EU members-states (witness the British scare a year ago about being deluged by “millions” of Bulgarians and Romanians) will  surely not accept 45 million impoverished Ukraine roaming the streets in search of jobs. It is thus with an exquisite hypocrisy that the British foreign secretary can speak about Ukraine being welcomed to its European “home” while, in the meantime, another part of his government makes sure that no Ukrainian  (unless he be an oligarch) makes it to England. (Just try, for exercise, filling British visa forms.)  The same is true for France and Germany. So, what Europe offered Ukraine was neither money, nor free movement of people, nor membership in the Union, but a mirage.

            On the other hand, Russia also offered a mirage. The ostensible reason why Putin found a rapprochement between Ukraine and Europe unacceptable was that it would not allow Ukraine to join Russia-designed Eurasian union that was supposed to include Russia, Belarus, Kazakhstan and Ukraine. Now, that Union was created in somebody head simply as a nice symmetrical idea in order to have something that would look, on paper, like a counterweight to the EU. But other than that idea and a meaningless meeting of the heads of states, that “Union” is a pure fiction:  with no observed rules of functioning, without joint policies, without common organization (where is the equivalent of the European commission? Where are the joint economic, let alone, political rules? Who is the head, government, committee of that august Eurasian  body?). It is yet another stillborn organization like the Commonwealth of Independent States. Even Kazakhstan and Belarus are having doubts about the membership, and despite both formally being in the Eurasian union, Russia and Belarus recently went into a trade war which sensibly led Lukashenko to cry: “We are not puppies to drag us by the scruff of the neck”.  

            Soviet Union, after creating the Comintern which for 10 years was a reasonably well functioning  organization (and which Stalin abolished at the insistence of the United States and the UK in 1943) never managed to create a real international organization. Both the Warsaw Pact and the CMEA were not only inefficient but simply extensions of Soviet domestic policies. The other members were pure figureheads with no autonomy of action. So for the Russians, creating an international organization is equivalent to saying, “you pretend to be members, but we decide all.” No one wants to join such an organization.

            Today’s Russia, with the exception of gas or oil, has nothing to offer to prospective members: it exports arbitrary government, equally arbitrary and unlawful privatizations (cheered by the West) and nationalizations (denounced by the West), individualized decision-making on everything from who is the Prime Minister to who controls the train-station in Perm, a relatively high level of income built on no serious production of any “real” goods or services, and full waste of all the high-skilled engineers, computer specialists, doctors, violinists, mathematicians, athletes created by the Soviet Union. In 25 years, Russia has wasted everything without creating anything.

            Since neither side cared about Ukraine as such, nor cared to give country money, support, free migration of labor or a meaningful role in either Europe or Eurasia, the only way Russia and Europe could pretend to do so was to offer chimeras in the hope of playing a geopolitical game that would upset the other side. Ukraine was thus pushed to choose between the two nothings, and divided as it is, chose a war. But soon the full costs of that choice, and irresponsible behaviors  of Russia and the West, will come to haunt us all, when the direct military conflict between the countries with a total of 20,000 nuclear missiles becomes a real possibility.


PS. A highly recommended book on how international organizations are created is  Mark Mazower's "Governing the world".